Tableof Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 
| **x** |   | **QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------|--------------------------------------------------------------------------------------------------------|

 

**For the quarterly period endedSeptember 30, 2008**

 

**or**

 
| **o** |   | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------|---------------------------------------------------------------------------------------------------------|

 

**For the transition period from              to              **

 

**Commission File Number 000-50405**

 

**ACUSPHERE, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                                                    | ** ** | **04-3208947**                    |
|-----------------------------------------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of incorporation  or organization) |       | (IRS Employer Identification No.) |
|                                                            |       |                              |
| **500 Arsenal Street**                                          |       |                              |
| **Watertown, Massachusetts**                                    | ** ** | **02472**                         |
| (Address of principal executive offices)                        |       | (Zip Code)                        |

 

Registrant’s Telephone Number, Including Area Code: **(617) 648-8800**

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, a non-accelerated filer or a smaller reportingcompany. See the definitions of “large accelerated filer,” “accelerated filer”and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Checkone):

 
| Large accelerated filer o                                                   |   | Accelerated filer x               |
|-----------------------------------------------------------------------------|--------|-----------------------------------|
| Non-accelerated filer o

**(**Do not check if a smaller reporting  company) |   | Smaller reporting company  o |

 

Indicate by check mark whether the registrant is a shell company (as definedin Rule 12b 2 of the Exchange Act). Yes o  No x

 

As of November 6, 2008 there were 49,506,766 shares of theregistrant’s common stock, $.01 par value per share, outstanding.

 

 

 

----

Table of Contents

 

**ACUSPHERE, INC.**

 

**Form 10-Q**

**For the Quarterly Period Ended September 30, 2008**

 

**CONTENTS**

 
| ** **                                                                                                        | **Page  Number** |
|-------------------------------------------------------------------------------------------------------------------|------------------|
| PART I:  FINANCIAL INFORMATION                                                                               |             |
| Item  1. Consolidated Financial Statements                                                                        |             |
| Consolidated Balance Sheets:  September 30, 2008 (Unaudited) and December 31, 2007                      | 3                |
| Consolidated Statements of  Operations (Unaudited):  Three and Nine Months ended September 30, 2008 and 2007 | 4                |
| Consolidated Statements of  Cash Flows (Unaudited):  Nine Months ended September 30, 2008 and 2007           | 5                |
| Notes to Consolidated  Financial Statements (Unaudited)                                                           | 6                |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations              | 18               |
| Item 3. Quantitative and Qualitative Disclosure about  Market Risk                                                | 35               |
| Item 4. Controls and  Procedures                                                                                  | 35               |
| PART II: OTHER  INFORMATION                                                                                  | 36               |
| Item 1. Legal Proceedings                                                                                         | 36               |
| Item  1A. Risk Factors                                                                                            | 36               |
| Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                              | 53               |
| Item 3.  Defaults Upon Senior Securities                                                                          | 53               |
| Item 4.  Submission of Matters to a Vote of Security Holders                                                      | 53               |
| Item 5. Other Information                                                                                         | 54               |
| Item  6. Exhibits                                                                                                 | 54               |
| Signature                                                                                                         | 55               |

 

2

----

Table ofContents

 

**PART I: FINANCIAL INFORMATION**

**ITEM 1. CONSOLIDATED FINANCIALSTATEMENTS**

**ACUSPHERE, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED BALANCE SHEETS**

**(in thousands except share data)**

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **As of**               | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **(unaudited)**              | ** ** | ** ** | ** ** |
| CURRENT ASSETS:                                                                                                                                                                                                                                                                                                                                                                                | ** ** | ** **                   | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                                                                                           |       | $                            | 4,112      |   | $ | 26,102 |   |
| Other current assets                                                                                                                                                                                                                                                                                                                                                                                |       | 1,583                        |       | 1,265 |   |
| Total current assets                                                                                                                                                                                                                                                                                                                                                                                |       | 5,695                        |       | 27,367 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                |       |                         |       |   |   |
| PROPERTY AND EQUIPMENT                                                                                                                                                                                                                                                                                                                                                                              |       |                         |       |   |   |
| Property and equipment, at cost:                                                                                                                                                                                                                                                                                                                                                                    |       | 55,002                       |       | 54,941 |   |
| Less accumulated depreciation and amortization                                                                                                                                                                                                                                                                                                                                                      |       | (39,231                      | )          | (31,699 | ) |
| Property and equipment, net                                                                                                                                                                                                                                                                                                                                                                         |       | 15,771                       |       | 23,242 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                |       |                         |       |   |   |
| OTHER ASSETS                                                                                                                                                                                                                                                                                                                                                                                        |       | 1,334                        |       | 1,411 |   |
| TOTAL ASSETS                                                                                                                                                                                                                                                                                                                                                                                        |       | $                            | 22,800     |   | $ | 52,020 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                |       |                         |       |   |   |
| **LIABILITIES  AND STOCKHOLDERS’(DEFICIT)/EQUITY**                                                                                                                                                                                                                                                                                                                                             |
| CURRENT LIABILITIES:                                                                                                                                                                                                                                                                                                                                                                                |       |                         |       |   |   |
| Current portion of long-term obligations                                                                                                                                                                                                                                                                                                                                                            |       | $                            | 10,225     |   | $ | 8,556 |   |
| Accrued expenses                                                                                                                                                                                                                                                                                                                                                                                    |       | 4,404                        |       | 3,596 |   |
| Current portion of deferred revenue                                                                                                                                                                                                                                                                                                                                                                 |       | 2,545                        |       | 4,667 |   |
| Current portion of deferred revenue - related party                                                                                                                                                                                                                                                                                                                                                 |       | 750                          |       | 0 |   |
| Accounts payable                                                                                                                                                                                                                                                                                                                                                                                    |       | 882                          |       | 1,994 |   |
| Dividend payable                                                                                                                                                                                                                                                                                                                                                                                    |       | 756                          |       | 0 |   |
| Derivative liability                                                                                                                                                                                                                                                                                                                                                                                |       | 64                           |       | 13 |   |
| Total current liabilities                                                                                                                                                                                                                                                                                                                                                                           |       | 19,626                       |       | 18,826 |   |
| LONG-TERM LIABILITIES:                                                                                                                                                                                                                                                                                                                                                                              |       |                         |       |   |   |
| Long-term obligations, net of current portion                                                                                                                                                                                                                                                                                                                                                       |       | 3,246                        |       | 9,454 |   |
| Deferred revenue, net of current portion                                                                                                                                                                                                                                                                                                                                                            |       | 1,386                        |       | — |   |
| Deferred revenue – related party, net of current  portion                                                                                                                                                                                                                                                                                                                                      |       | 8,875                        |       | — |   |
| Total long-term liabilities                                                                                                                                                                                                                                                                                                                                                                         |       | 13,507                       |       | 9,454 |   |
| COMMITMENTS                                                                                                                                                                                                                                                                                                                                                                                         |       |                         |       |   |   |
| STOCKHOLDERS’ (DEFICIT)/EQUITY:                                                                                                                                                                                                                                                                                                                                                                |       |                         |       |   |   |
| Preferred stock, $0.01 par value per share                                                                                                                                                                                                                                                                                                                                                          |       |                         |       |   |   |
| Authorized - 5,000,000 shares as of  September 30, 2008 and December 31, 2007; Designated 6.5%  convertible exchangeable -1,000,000 shares as of September 30, 2008 and  December 31, 2007; issued and outstanding 480,000 shares as of  September 30, 2008 and 690,000 shares as of December 31, 2007  (liquidation value $24,000,000 as of September 30, 2008) |       | 5                            |       | 7 |   |
| Common stock, $0.01 par value per share                                                                                                                                                                                                                                                                                                                                                             |       |                         |       |   |   |
| Authorized, 98,500,000 shares as of  September 30, 2008 and December 31, 2007; issued and outstanding  48,070,622 shares as of September 30, 2008 and 46,273,945 as of  December 31, 2007                                                                                                                                                                                       |       | 481                          |       | 463 |   |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                                                                                          |       | 358,872                      |       | 358,141 |   |
| Accumulated deficit                                                                                                                                                                                                                                                                                                                                                                                 |       | (369,691                     | )          | (334,871 | ) |
| Total stockholders’ (deficit)/equity                                                                                                                                                                                                                                                                                                                                                           |       | (10,333                      | )          | 23,740 |   |
| TOTAL LIABILTIES & STOCKHOLDERS’  (DEFICIT)/EQUITY                                                                                                                                                                                                                                                                                                                                    |       | $                            | 22,800     |   | $ | 52,020 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

3

----

Table of Contents

 

**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(unaudited, in thousands)**

 
| ** **                                                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                 | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                 | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                       |       |                             |       |                            |       |   |   |   |   |
| **REVENUE (1)**                                            |       | $                                | 339        |                            | $          | 667 |   | $ | 1,860 |   | $ | 2,000 |   |
|                                                       |       |                             |       |                            |       |   |   |   |   |
| OPERATING EXPENSES:                                        |       |                             |       |                            |       |   |   |   |   |
| Research and development                                   |       | 7,503                            |       | 11,728                          |       | 27,211 |   | 32,571 |   |
| General and administrative                                 |       | 2,772                            |       | 3,092                           |       | 8,595 |   | 9,669 |   |
| Total operating expenses                                   |       | 10,275                           |       | 14,820                          |       | 35,806 |   | 42,240 |   |
|                                                       |       |                             |       |                            |       |   |   |   |   |
| Interest income                                            |       | 45                               |       | 629                             |       | 311 |   | 1,912 |   |
| Other income                                               |       | 55                               |       | —                          |       | 55 |   | — |   |
| Loss on extinguishment of debt                             |       | —                           |       | —                          |       | — |   | (1,146 | ) |
| Interest expense                                           |       | (332                             | )          | (490                            | )          | (1,125 | ) | (1,589 | ) |
| Change in valuation of derivative                          |       | (115                             | )          | 13                              |       | (115 | ) | (106 | ) |
| NET LOSS                                                   |       | (10,283                          | )          | (14,001                         | )          | (34,820 | ) | (41,169 | ) |
|                                                       |       |                             |       |                            |       |   |   |   |   |
| Dividends on preferred stock                               |       | (390                             | )          | (561                            | )          | (1,446 | ) | (1,714 | ) |
|                                                       |       |                             |       |                            |       |   |   |   |   |
| NET LOSS AVAILABLE TO COMMON STOCKHOLDERS                  |       | $                                | (10,673    | )                               | $          | (14,562 | ) | $ | (36,266 | ) | $ | (42,883 | ) |
|                                                       |       |                             |       |                            |       |   |   |   |   |   |   |   |   |
| NET LOSS AVAILABLE TO COMMON STOCKHOLDERS PER SHARE – |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                          |       | $                                | (0.23      | )                               | $          | (0.32 | ) | $ | (0.78 | ) | $ | (1.04 | ) |
|                                                       |       |                             |       |                            |       |   |   |   |   |   |   |   |   |
| WEIGHTED-AVERAGE SHARES OUTSTANDING –                 |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted                                          |       | 47,218                           |       | 46,213                          |       | 46,791 |   | 41,411 |   |
|                                                            |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

----

**(1)****          **Includesrelated-party amounts of approximately $0.2 million and $0.3 million,respectively, for the three and nine months ended September 30, 2008 (seeNote 10).

 

4

----

Table of Contents

 

**ACUSPHERE,INC. AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(unaudited, in thousands)**

** **
| ** **                                                                   | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                   | ** ** | **Sept. 30,**              | ** ** | **Sept. 30,** | ** ** |
| ** **                                                                   | ** ** | **2008**                        | ** ** | **2007** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Net loss                                                                     |       | $                               | (34,820    | ) | $ | (41,169 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities: |       |                            |       |   |   |
| Stock-based compensation expense                                             |       | 1,429                           |       | 1,851 |   |
| Depreciation and amortization                                                |       | 7,544                           |       | 7,583 |   |
| Loss on disposal of property and equipment                                   |       |                            |       | 249 |   |
| Loss on extinguishment of debt                                               |       | —                          |       | 1,146 |   |
| Noncash interest expense                                                     |       | 553                             |       | 657 |   |
| Noncash rent expense                                                         |       | (144                            | )          | 8 |   |
| Noncash amortization of deferred revenue                                     |       | (1,860                          | )          | (2,000 | ) |
| Noncash amortization of fee and warrants to  financial advisor               |       | 247                             |       | 168 |   |
| Noncash change in valuation of derivative                                    |       | 115                             |       | 106 |   |
| Changes in operating assets and liabilities:                                 |       |                            |       |   |   |
| Deferred revenue                                                             |       | 10,750                          |       | — |   |
| Other current assets                                                         |       | (538                            | )          | (66 | ) |
| Accounts payable                                                             |       | (1,112                          | )          | (116 | ) |
| Accrued expenses                                                             |       | 741                             |       | 964 |   |
| Net cash used in operating activities                                        |       | (17,095                         | )          | (30,619 | ) |
|                                                                         |       |                            |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                        |       |                            |       |   |   |
| Purchases of property and equipment                                          |       | (73                             | )          | (769 | ) |
| Increase in other assets                                                     |       |                            |       | 24 |   |
| Net cash used in investing activities                                        |       | (73                             | )          | (745 | ) |
|                                                                         |       |                            |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                        |       |                            |       |   |   |
| Payments on long-term obligations                                            |       | (4,832                          | )          | (6,897 | ) |
| Proceeds from long-term obligations                                          |       | —                          |       | 901 |   |
| Net proceeds from sale of stock                                              |       | —                          |       | 18,698 |   |
| Payment of preferred stock dividends                                         |       | —                          |       | (1,714 | ) |
| Proceeds from exercise of stock options                                      |       | —                          |       | 97 |   |
| Proceeds from issuance of common stock from employee  stock purchase plan    |       | 10                              |       | 39 |   |
| Net cash (used in) provided by financing activities                          |       | (4,822                          | )          | 11,124 |   |
|                                                                         |       |                            |       |   |   |
| NET DECREASE IN CASH AND CASH EQUIVALENTS                                    |       | (21,990                         | )          | (20,240 | ) |
|                                                                         |       |                            |       |   |   |
| CASH AND CASH EQUIVALENTS, Beginning of period                               |       | 26,102                          |       | 59,750 |   |
| CASH AND CASH EQUIVALENTS, End of period                                     |       | $                               | 4,112      |   | $ | 39,510 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

5

----

Table of Contents

 

**ACUSPHERE, INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(unaudited)**

 

**1. Basis of Presentation**

 

The accompanyingunaudited consolidated financial statements of Acusphere, Inc. andSubsidiaries (“Acusphere” or the “Company”), have been prepared in accordancewith generally accepted accounting principles in the United States of Americafor interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all ofthe information and footnotes required by generally accepted accountingprinciples in the United States of America for complete financial statements.These statements should be read in conjunction with the consolidated financialstatements and notes thereto included in the Company’s latest audited annualfinancial statements. Those audited statements are included in our AnnualReport on Form 10-K for the year ended December 31, 2007, which hasbeen filed with the SEC.

 

Acusphere is a specialty pharmaceutical company that develops new drugsand improved formulations of existing drugs using its proprietary microparticletechnology. The Company is focused on developing proprietary drugs that canoffer significant benefits over existing drugs, including improved safety andefficacy, increased patient compliance, greater ease of use, expandedindications or reduced cost. The Company’s lead product, ImagifyTM (perflubutane polymer microspheresfor delivery in an injectable suspension, pronounced i-maj’-i-fi, formerlyknown as AI-700) is a cardiovascular drug for the detection of coronaryartery disease, the leading cause of death in the United States. The Companysubmitted a new drug application (NDA) with the U.S. Food and DrugAdministration (FDA) for Imagify on April 28, 2008 which was accepted bythe FDA for review on June 30, 2008. With a standard review, under the FDAPrescription Drug User Fee Act (PDUFA), the target action date is 10 monthsfrom the submission date, or February 28, 2009. The Company also hasdemonstrated that its technology has the potential to improve the formulationof hydrophobic drugs and asthma drugs.

 

The Company is subject to a number of risks similar to those ofpre-commercial stage companies, including dependence on key individuals,uncertainty of product development and generation of revenues, dependence onoutside sources of capital, risks associated with clinical trials, dependenceon third party collaborators for research operations, need for regulatoryapproval of products, successful protection of intellectual property, andcompetition with larger, better-capitalized companies.

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements, and the reported amounts of expensesduring the reporting period. Actual results could differ from those estimatesor assumptions. The more significant estimates reflected in these financialstatements relate to revenue recognition, accrued expenses, embeddedderivatives, and valuation of stock-based compensation.

 

Going Concern Presentation – As of September 30, 2008, the Companyhad cash and cash equivalents of $4.1 million, current liabilities of $19.6million and stockholders’ deficit of $10.3 million. During the nine monthsended September 30, 2008, the Company incurred a net loss available tocommon stockholders of $36.3 million. During the nine months ended September 30,2008, operating activities used approximately $17.1 million of cash. Asdescribed in Note 12, the Company obtained $20.0 million in funding on November 3,2008. However, given the Company’s results from operations, current forecasts,and financial position as of September 30, 2008, the Company will requiresignificant additional funds in order to fund operations through and beyond thesecond quarter of 2009. These conditions raise substantial doubt about theCompany’s ability to continue as a going concern. The accompanying financialstatements have been prepared on the basis of a going concern assumption and donot reflect any adjustments that might result from the outcome of thisuncertainty.

 

Management’s Plans – As a result of its limited capital resources, theCompany has elected to delay and may continue to elect to delay the funding ofcertain development activities, including activities related to thecommercialization of Imagify, which could harm its financial condition andoperating results. The depletion of its resources may make future funding moredifficult or expensive to attain. The Company may raise additional fundsthrough public or private sales of equity or from borrowings or from strategicpartners. Future capital requirements will depend on many factors, includingthe scope and progress made in research and development activities and the sizeand timing of creating expanded manufacturing capabilities. There are noassurances, however, that the Company will obtain additional financing onfavorable terms, or at all, or successfully market its products. If the Companyis unable to obtain additional financing, it will be forced to ceaseoperations.

 

6

----

Table ofContents

** **

**2. Revenue Recognition and Deferred Revenue**

 

The Company recognizes revenue from licensearrangements in accordance with Staff Accounting Bulletin No. 104, RevenueRecognition (“SAB 104”) and Financial Accounting Standards Board (“FASB”)Emerging Issue Task Force Issue No. 00-21, Accounting for RevenueArrangements with Multiple Deliverables (“EITF 00-21”). The Company recognizesrevenue from license payments not tied to achieving a specific performancemilestone ratably over the period over which the Company is obligated toperform services. The period over which the Company is obligated to performservices is estimated based on available facts and circumstances.  The Company periodically evaluates theassumptions underlying these estimates; significant changes in theseassumptions could result in an adjustment to the period over which the revenueis recognized. The Company recognizes revenue from performance payments, whensuch performance is substantially in the Company’s control and when the Companybelieves that completion of such performance is reasonably probable, ratablyover the period over which the Company estimates that it will perform suchperformance obligations. Substantive at-risk milestone payments, which arebased on achieving a specific performance milestone when performance of suchmilestone is contingent on performance by others or for which achievement cannot be reasonably estimated or assured, are recognized as revenue when themilestone is achieved and the related payment is due, provided that there is nosubstantial future service obligation associated with the milestone. Revenue inconnection with license arrangements is recognized over the term of thearrangement and is limited to payments collected or due and reasonably assuredof collection. In circumstances where the arrangement includes a refundprovision, the Company defers revenue recognition until the refund condition isno longer applicable unless, in the Company’s judgment, the refundcircumstances are within its operating control and unlikely to occur.  Payments received in advance of beingrecognized as revenue are deferred. Contract amounts which are not due until the customer accepts orverifies the research results are not recognized as revenue until customeracceptance, assuming collectability is reasonably assured.

 

On March 28, 2008, the Company entered into a license agreement(the “Cephalon License”) with Cephalon, Inc. (“Cephalon”), a related party(See Note 10), providing Cephalon with an exclusive, worldwide license to theCompany’s Hydrophobic Drug Delivery System (HDDS) for oncology applications,along with the rights to AI-850, the Company’s formulation of paclitaxel, inexchange for a cash payment of $10.0 million, paid upon the execution of theagreement.  The term of the agreement extends until expiration of the lastof the patents licensed under the agreement. During the term of the license the Company is obligated to supportCephalon activities in connection with AI-850. This support includes allowing access to Acusphere personnel fordiscussions relating to regulatory, scientific and medical technology and allowaccess to any records that may be required in connection with any regulatoryfilings or submissions.  On September 2,2008, the Company entered into a letter agreement amending the CephalonLicense.  The amendment did not modifythe accounting treatment with respect to the Cephalon License.  The Company has recorded this payment indeferred revenue at September 30, 2008, and is recognizing it as incomeratably over the remaining estimated useful life of the patents, orapproximately 13 years.  The Companybegan recognizing revenue under the Cephalon License in the second quarter of2008.

 

In July 2004, the Company entered into a collaboration, licenseand supply agreement with Nycomed Danmark APS (“Nycomed”) in which the Companygranted Nycomed rights to develop and market Imagify in Europe.  As of September 30, 2008, Nycomed haspaid $12.0 million in license fees for the Company’s research and developmentefforts, which is being recognized ratably in revenue over the developmentperiod.  Estimation of this developmentperiod involves the evaluation of many assumptions and uncertainties inherentin the performance of a long-term development project.  The Company regularly evaluates theseassumptions and uncertainties and the estimated development recognition periodmay change if facts and circumstances change.  There was no change in theamortization period during the year ended December 31, 2007.   During the third quarter of 2008, managementreevaluated the assumptions underlying the development term and revised theestimated development period from 54 months to 66 months.  The remaining $2.7million of the $12.0 million in development payments already received, but yetto be recognized as revenue, is included in deferred revenue at September 30,2008 and will be recognized over the remaining estimated development period.

 

In October 2005 and February 2006, the Company and Nycomedamended the collaboration agreement to accelerate $2.0 million in milestonepayments in order to fund certain activities associated with brand developmentand qualification of a commercial manufacturing facility. The $2.0 million inpayments received pursuant to these amendments were considered advances againsta future milestone payment for a European regulatory filing, or MarketingAuthorization Application (“MAA”). In September 2008, the arrangement withNycomed was amended.  This amendmentremoved a contingency associated with the $2.0 million of payments.  As a result the $2.0 million has beenincluded with the aforementioned $12 million and is being recognized over the66 month development period utilizing the cumulative catch-up methodology.  Approximately $0.5million of the $2.0 million in development payments already received, but yetto be recognized as revenue, is included in deferred revenue at September 30,2008 and will be recognized over the remaining estimated development period.

 

7

----

Table of Contents

 

On June 26, 2008, the Company executed the Third Amendment (the “ThirdAmendment”) to the Collaboration, License and Supply Agreement dated July 6,2004 with Nycomed, as amended, for the European development and marketingrights to Acusphere’s product candidate AI-700 or ImagifyTM (the “Product”). Pursuant to the Third Amendment, Nycomed shall reimburse the Company forexpenses arising from and after June 1, 2008 and related to the Company’squalification of its commercial manufacturing facility in Tewksbury,Massachusetts.  Such amounts shall not, in the aggregate, exceed $750,000and are payable by Nycomed upon receipt of monthly invoices.  The ThirdAmendment further provides that $750,000 shall be credited against Nycomed’sinitial purchases of the Product so that Nycomed shall only pay for Productsdelivered after such $750,000 has been fully credited.  The Company has included the $750,000 inlong-term deferred revenue.

** **

**3. Stock-basedCompensation**

** **

***Accounting for Stock-BasedCompensation Plans***

*** ***

Effective January 1, 2006, the Company adopted SFAS No. 123R,*Share-Based Compensation* (“SFAS 123R”)using the modified prospective method, which results in the provisions of SFAS123R being applied to the consolidated financial statements on a going-forwardbasis. SFAS 123R requires companies to recognize stock-based compensationawards granted to its employees as compensation expense on a fair value method.Under the fair value recognition provisions of SFAS 123R, stock-basedcompensation cost is measured at the grant date based on the fair value of theaward and is recognized as expense over the service period, which generallyrepresents the vesting period. The grant date fair value of stock options iscalculated using the Black-Scholes option-pricing model and the grant date fairvalue of restricted stock is based on intrinsic value. The expense recognizedover the service period is required to include an estimate of the awards thatwill be forfeited.

 

All stock-based awards to non-employees are accounted for at their fairvalue in accordance with SFAS 123R and Emerging Issues Task Force No. 96-18,*Accounting for Equity Instruments That Are Issuedto Other Than Employees for Acquiring, or in Conjunction with Selling, Goods orServices*. Under this method, the equity-based instrument was valuedat either the fair value of the consideration received or the equity instrumentissued on the date of grant. The resulting compensation cost was recognized andcharged to operations over the service period, which was usually the vestingperiod.

 

Stock compensation expense under SFAS 123R for the three and ninemonths ended September 30, 2008 and 2007 is as follows (in millions):

 
| ** **                        | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                        | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Research & development   |       | $                                                        | 0.2        |                                                    | $          | 0.3 |   | $ | 0.7 |   | $ | 0.8 |   |
| General & administrative |       | 0.2                                                      |       | 0.3                                                     |       | 0.7 |   | 1.0 |   |
| Total                             |       | $                                                        | 0.4        |                                                    | $          | 0.6 |   | $ | 1.4 |   | $ | 1.8 |   |

 

In accordance with SFAS 123R, the Company will report any excesstax benefits from the exercise of non-qualified stock options as financing cashflows.  There were no excess tax benefitsrecorded from the exercise of non-qualified stock options for the nine monthsended September 30, 2008 and 2007.

 

For purposes of recording stock option-basedcompensation expense, the fair values of each stock option granted under theCompany’s stock option plan were estimated as of the date of grant using theBlack-Scholes option-pricing model. The weighted average fair value of allstock option grants issued for the three months ended September 30, 2008and 2007 were $0.36 and $0.81, respectively, and for the nine months ended September 30,2008 and 2007 were $0.33, and $1.27, respectively.

 

The fair values of all stock option grants issued weredetermined using the following weighted average assumptions:

 
| ** **                               | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                               | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                               | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Risk-free  interest rate                 |       | 3.45                                                     | %          | 4.31                                                    | %          | 2.96 | % | 4.77 | % |
| Expected  volatility of underlying stock |       | 76.4                                                     | %          | 54.71                                                   | %          | 65.58 | % | 51.00 | % |
| Expected life of  option grants (years)  |       | 5.0                                                      |       | 5.0                                                     |       | 5.0 |   | 5.0 |   |
| Expected dividends                       |       | 0                                                        |       | 0                                                       |       | 0 |   | 0 |   |

 

8

----

Table of Contents

 

The fair values of options granted during six-month period ended August 31,2008 and 2007 under the Company’s Purchase Plan were calculated using thefollowing weighted-average assumptions:

 
| ** **                               | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|
| Risk-free interest rate                  |       | 1.97     | %          | 4.21     | %          |
| Expected volatility of  underlying stock |       | 75.9     | %          | 54.40    | %          |
| Expected life of option (years)          |       | 0.5      |       | 0.5      |       |

 

***Stock OptionActivity***

 

During the three months ended September 30, 2008, the Companygranted stock options to existing employees, as part of the Company’sperformance review process and new employees and directors. All such optionswere granted with exercise prices equal to the current market value of theunderlying common stock on the date of grant.

 
| ** **                                          | ** ** | ** **         | ** ** | ** **              | ** ** | **Weighted Average** | ** ** | ** **          | ** ** |
|-----------------------------------------------------|------------|--------------------|------------|-------------------------|------------|---------------------------|------------|---------------------|------------|
| ** **                                          | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** | **Exercise Price**   | ** ** | **Grant Date** | ** ** |
| ** **                                          | ** ** | **Shares**         | ** ** | **Per Share**      | ** ** | **Per Share**        | ** ** | **Fair Value** | ** ** |
| For the three months ended September 30, 2008: |       | 685,903            |       | $                       | 0.56       |                      | $          | 0.56                |       | $ | 245,896 |   |
|                                                     |            |                    |            |                         |            |                           |            |                     |            |  |  |  |

 

On August 31, 2008, the company issued 12,927 shares of its commonstock under the Purchase Plan at $0.38 per share, reflecting 85% of the closingstock price.

 

Stock option activity for the nine months ended September 30,2008:

 
| ** **                                          | ** ** | **Number of  Shares** | ** ** | **Exercise Price   Per Share** | ** ** | **Weighted-  Average  Exercise  Price Per  Share** | ** ** | **Weighted-  Average  Remaining  Contractual  Life** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------------------------|------------|----------------------------|------------|-----------------------------------------------|------------|---------------------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|
| Balance, January 1, 2008                       |       | 4,679,776                  |       | $0.63 - $13.02                                |       | $                                                       | 4.99       |                                                 |       |                            |       |   |
| Granted                                             |       | 3,182,874                  |       | 0.56 - 0.68                                   |       | 0.59                                                    |       |                                                 |       |                            |       |
| Exercised                                           |       | —                     |       | —                                        |       | —                                                  |       |                                                 |       |                            |       |
| Forfeited                                           |       | (1,164,470                 | )          | 0.56 - 13.02                                  |       | 2.68                                                    |       |                                                 |       |                            |       |
| Balance, September 30, 2008                    |       | 6,698,180                  |       | $0.56 - $13.02                                |       | $                                                       | 3.30       |                                                 | 7.5        |                            | $          | 0 |   |
|                                                |       |                       |       |                                          |       |                                                    |       |                                                 |       |                            |       |
| Vested or Expected to Vest, September 30, 2008 |       | 6,056,649                  |       | $0.55 - $13.02                                |       | 3.30                                                    |       | 7.5                                                  |       | $                               | 0          |   |
| Exercisable, September 30, 2008                |       | 3,565,704                  |       | 0.56 - 13.02                                  |       | 5.05                                                    |       | 6.0                                                  |       | $                               | 0          |   |

 

As of September 30, 2008, there was $1.8million of total expected unrecognized compensation costs related to unvestedstock options under the Company’s stock-based plans.  That cost is expected to be recognized over aweighted-average period of 2.9 years.

 

**4. Net Loss Per Common Share**

** **

Basic and dilutednet loss per common share is calculated by dividing the net loss available tocommon stockholders by the weighted-average number of unrestricted commonshares outstanding during the period. Diluted net loss per common share is thesame as basic net loss per common share, since the effects of potentiallydilutive securities are anti-dilutive for all periods presented. As of September 30,2008 and 2007, anti-dilutive securities, which consist of convertibleexchangeable preferred stock, stock options, warrants, and restricted commonstock that are not included in the diluted net loss per share calculationaggregated 18,973,154 and 19,435,320 shares, respectively.

 

9

----

Table of Contents

 

**5. Balance Sheet Data**

** **

**(**in thousands)

 
| ** **                                 | ** ** | **September  30, 2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Other assets consist of the following:     |       |                         |       |                        |       |
| Deposits                                   |       | $                            | 1,139      |                        | $          | 1,126 |   |
| Other assets                               |       | 195                          |       | 285                         |       |
|                                       |       | $                            | 1,334      |                        | $          | 1,411 |   |
|                                       |       |                         |       |                        |       |
| Accrued expenses consist of the following: |       |                         |       |                        |       |
| Accrued contract services                  |       | $                            | 826        |                        | $          | 1,404 |   |
| Accrued vacation (1)                       |       | 67                           |       | 517                         |       |
| Accrued bonus (2)                          |       | 1,028                        |       | 129                         |       |
| Other accrued expenses (3)                 |       | 2,483                        |       | 1,546                       |       |
|                                       |       | $                            | 4,404      |                        | $          | 3,596 |   |

 

----

Note (1) –The Company’s current vacation policy allows employees to carry over unusedvacation time as of December 31 of each year, up to a maximum of twoweeks.  However, several employees whojoined the Company prior to the institution of this vacation policy hadaccumulated more than two weeks vacation at December 31, 2007.  These employees had been allowed to carrythis excess vacation accrual forward each year. In April 2008 approximately $0.7 million of this accumulatedvacation liability to employees was paid in a lump sum payment.

 

Note (2) – On July 28, 2008, the Company announced that,pursuant to the Senior Management Compensation Plan approved by theCompensation Committee of the Company’s Board of Directors on July 25,2008, all senior managers at the Vice President level and above (“Management”)took salary reductions of 10% or more, to further decrease operating costswhile the Company awaits Food and Drug Administration (“FDA”) review of its NewDrug Application (“NDA”) for ImagifyTM (Perflubutane Polymer Microspheres forInjectable Suspension). The salary reductions described were effective on August 1,2008.  In connection with such reductions and pursuant to the SeniorManagement Compensation Plan, on July 25, 2008 the Compensation Committeeand the Board of Directors granted common stock option awards to each member ofManagement pursuant to the Company’s 2005 Stock Option and Incentive Plan. The options vest 100% upon completionof the first debt or equity financing in excess of $10 million by the Companyafter the Prescription Drug User Fee Act (“PDUFA”) date,currently expected to be February 28, 2009, for Imagify or upon anacquisition of the Company (a “Qualified Financing”). Each member of Management who is still employed by the Companyupon the completion of a Qualified Financing will also receive a cash bonusequal to the total amount of pre-reduction base salary forgone as a result ofthe Management base salary reduction; provided that members of Management mayalso elect to take additional base salary reductions in exchange for a largercash retention bonus and option grant.  For reductions of 20%, for everydollar of pay cut there will be two dollars of cash retention bonus and twicethe level of option grants.

 

In September 2008,the Board approved a supplemental bonus program for full time employeesemployed by the Company as of September 15, 2008.  Employees who carry the title of VicePresident or above are not eligible for this program.  The amount of the bonus will be 25% of suchemployee’s base salary at the time of the payment.  The bonus is contingent upon such employeesremaining an employee of the Company through the FDA’s complete response letterto the Company’s NDA for Imagify which is expected on or about the PDUFA actiondate of February 28, 2009.  Inaddition, the bonus is further contingent upon the Board’s determination thatthe Company completed a financing to provide sufficient funding to make theproposed bonus payment.  If thecontingencies are met and all employees eligible remained through that date,the bonus would amount to approximately $1.3 million.

** **

The Company began ratablyaccruing for these bonuses in September 2008 and the accrued amount atSeptember 30, 2008 was approximately $300,000.

 

Note (3) –Includes an $0.6 million payable under an intellectual property licenseagreement with Bracco.  On July 29,2008, the Company entered into an amendment (the “Amendment”) to the Bracco InternationalBV patent license agreement.  See “Footnote6. Intellectual Property”.

 

**6. Intellectual Property**

** **

The Company expenses intellectual property costs incurred in obtaininglicense right and patent rights to technology or products for which technologicalfeasibility has not been commercially demonstrated and no alternative futureuse has been shown to exist.  No amount has been capitalized by theCompany relating to the costs of intellectual property developed or acquired bythe Company.

 

On June 1, 2006, the Company entered into an agreement to licenseon a non-exclusive basis various ultrasound-related intellectual property fromGE Healthcare (“GE”), a division of General Electric Company. In considerationof the non-exclusive license of these patents, the Company agreed to pay GE$10.0 million prior to commercial approval of Imagify, of which $5.0 millionwas paid in 

 

10

----

Table of Contents

 

June 2006 and $5.0 million was due in June 2007.  Effective May 11, 2007 the Companyentered into an amendment (the “First GE Amendment”) to the GE patent licenseagreement.  Pursuant to the First GE Amendment: $1.5 million was paid toGE in May 2007.    On May 15,2008, the Company entered into a second amendment (the “Second GE Amendment”)to the GE patent license agreement.  Under the First GE Amendment, theCompany was due to make a series of six (6) consecutive quarterlyinstallments of approximately $0.9 million due on the first day of the thirdmonth of each calendar quarter, commencing on June 1, 2008.  TheSecond GE Amendment provides that, in lieu of these payments, the Company shallmake a series of payments due as follows: $5.5 million due as of June 1,2007, payable in two installments commencing on June 1, 2008. The firstinstallment of $0.9 million is due on June 1, 2008 and was paid in May 2008and the remaining installment is due and payable on October 1, 2009 in anamount consisting of (i) the amount of approximately $4.6 million inprincipal plus (ii) interest accruing on such principal amount from July 1,2008 at the rate of 6% per annum until paid in full.  If receipt ofregulatory approval by the FDA to market Imagify in the United States, orthe approval of a Marketing Authorization Application (“MAA”) to marketImagify in Europe, is received prior to the October 1, 2009 due date,any then remaining balance of the approximately $4.6 million (plus interestaccrued to such date) payable as described above shall be immediately due andpayable in full. The other terms of the agreement are otherwiseunchanged.  The Company has included thecurrent carrying value of the remaining installment in the current portion oflong-term liabilities at September 30, 2008.

 

On June 1, 2006, the Company entered into an agreement to licenseon a non-exclusive basis various ultrasound-related intellectual property fromBracco International BV (“Bracco”). The agreement provides the Company with useof Bracco’s ultrasound-related patents and patent applications in combinationwith the Company’s lead product candidate Imagify in the field of ultrasounddiagnostic imaging. The term of the agreement extends until expiration of thelast of the patents licensed under the agreement.  In consideration for the non-exclusivelicense of these patents, the Company agreed to pay Bracco up to a total of Euros 3.0 million, ofwhich Euros 0.5 million (approximately $0.6 million) was paid in June 2006.On July 29, 2008, the Company entered into an amendment to the Braccopatent license agreement.  Under theBracco patent license agreement, the Company was obligated to make a payment ofEuros 500,000 (approximately $0.8 million) to Bracco within five business days afterthe acceptance by the FDA of a new drug application filing package forImagify.  The FDA accepted the Company’sapplication on June  30, 2008, making such payment to Bracco due on July 8,2008.  The Amendment reduces the amountof the payment due on July 8, 2008 to Euros 100,000 (approximately $0.2million), and provides that an additional payment of Euros 400,000(approximately $0.6 million) will be due on the first anniversary of suchacceptance by the FDA, or June 30, 2009. The Amendment further provides that the Company grants Bracco aperpetual non-exclusive and royalty-free right and license within the field ofultrasound diagnostic imaging to use and exploit any intellectual property thatthe Company has developed or may develop after June 1, 2006 which relatesto, or to the use or performance of, the patents licensed by Bracco under theAgreement.  The Company has made thepayment of Euro 100,000 (approximately $0.2 million) in August 2008 andthe remaining payment of Euros 400,000 (approximately $0.6 million) thatis due on the first anniversary of such acceptance by the FDA, or June 30,2009 is classified in current liabilities as of September 30, 2008.  An additional Euros 2.0 million is payableupon the Company’s achievement of certain defined regulatory milestones.  The Company also agreed to pay a royalty onfuture Imagify revenue, up to a maximum royalty amount of Euros 10.0 million,less a portion of the above-referenced milestone payments. These otherobligations have not been recorded at this time since they are contingent uponthe outcome of future events.

 

On May 11, 2005, the Company entered into a Patent TransferAgreement with Bayer Schering Pharma AG (“Schering”) pursuant to which theCompany acquired rights, title and interest in certain ultrasound-relatedpatents from Schering. In consideration of the transfer and assignment of thesepatents, the Company agreed to pay Schering a total of $7.0 million of which$1.0 million was paid in May 2005, $3.0 million was paid in May 2006,and $3.0 million was due in May 2007. Effective April 27, 2007 the Company entered into an amendment (the“First BSP Amendment”) to the Schering patent transfer agreement. Pursuant to the First BSP Amendment $1.5 million was paid in May 2007.  On May 15, 2008, the Company enteredinto a second amendment (the “Second BSP Amendment”) to the Schering patenttransfer agreement.  Under the First BSP Amendment, the Company was due tomake a payment of $1.0 million to Schering on or before fifteen days after May 11,2008 and a payment of another $1.0 million to Schering on or before fifteendays after May 11, 2009.  The Second BSP Amendment provides that, inlieu of these payments, the Company shall make a series of payments due asfollows: $200,000 on or before fifteen days following execution of the SecondBSP Amendment and $1.8 million on or before fifteen days after May 11,2009.  The $200,000 payment was paid in May 2008 and the currentcarrying value of the remaining $1.8 million has been included in the currentportion of long-term obligations at September 30, 2008.

 

**7. Long-term Obligations**

** **

The carrying valueof long-term obligations is as follows (in thousands):

 

11

----

Table of Contents

 
| ** **                                         | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Capital lease obligations                          |       | $                                | 47         |                            | $          | 67 |   |
| Notes payable                                      |       | 6,335                            |       | 10,029                          |       |
| Amounts due under intellectual property agreements |       | 6,092                            |       | 6,666                           |       |
| Operating Leases                                   |       | 997                              |       | 1,248                           |       |
| subtotal                                           |       | 13,471                           |       | 18,010                          |       |
| Less current maturities                            |       | (10,225                          | )          | (8,556                          | )          |
| Long-term obligations, net                         |       | $                                | 3,246      |                            | $          | 9,454 |   |

 

***Capital LeaseObligations***

*** ***

The Company leases capital equipment through Banc of America LeasingCorporation. The remaining monthly payments range from $460 to $1,019 withmaturities through June 2010. Interest rates for the above leases rangefrom 7.3% to 9.4%. Acusphere does not have any additional borrowingavailability under these lease arrangements as of September 30, 2008.  At September 30, 2008 and December 31,2007, the cost and net carrying value of equipment under capital leasesamounted to approximately $47,000 and$67,000, respectively.

 

***Notes Payable***

*** ***

***EquipmentPromissory Notes—***In 2004 and 2005, the Company borrowedan aggregate of $10.5 million under an equipment financing line with GE CapitalCorporation. In January 2006, the line was amended and the availabilitywas increased by an additional $3.5 million and was extended through May 2007.During the year ended December 31, 2007, the Company borrowedapproximately $0.9 million, no additional amounts may be borrowed under thisline.  Borrowings are collateralized byequipment and other capital purchases made with the proceeds from these notes,with repayment due in monthly installments over 36 to 48 months, depending onthe nature of the equipment financed, with the last such repayment scheduledfor December 2010. Interest rates onthese borrowings were fixed at the time of each borrowing and range from 8.7%to 10.7%. The loans under this line are subject to acceleration upon certainevents of default, including but not limited to: i) the failure to make timelypayments of principal and interest, ii) a default on other materialobligations, or iii) a material adverse change in the financial condition ofthe borrower.  As of September 30,2008, net of repayments, the Company had $2.5million outstanding under the line.

 

In 2005 the Company borrowed an aggregate of $7.0 million under anequipment financing line with Oxford Finance Corporation. As of September 30,2008, net of repayments, the Company had $2.0 million outstanding under theline. Borrowings are collateralized by the equipment financed, with repaymentdue in monthly installments over 36 to 48 months, with the last suchrepayment scheduled for March 2010. Interest rates on these borrowingswere fixed at the time of each borrowing and range from 10.3% to 10.9%. Theloans under this line are subject to acceleration upon certain events ofdefault, including but not limited to the failure to make timely payments ofprincipal and interest, a default on other material obligations, or a materialadverse change in the financial condition of the borrower.  No additional amount may be borrowed underthis line.

 

***Facility LoanAgreement—*** In March 2005 the Company borrowed$2.0 million under a loan agreement with MassDevelopment to help financecertain tenant improvements to its commercial manufacturing facility inTewksbury, Massachusetts. The loan is secured by certain improvements made atthe facility, interest accrues at 5.0% per annum with retroactive adjustmentsto 9.0% in the event the Company achieves positive operating cash flow, asdefined in the agreement, prior to repayment of the loan. Accrued principal andinterest are being repaid over a 10 year term. The loan is subject toacceleration upon certain customary events of default, including failure totimely pay principal and interest. Acusphere began making payments on this loanin May 2007 and as of September 30, 2008, has approximately $1.9million outstanding under the loan.

 

The retroactive interest rate adjustment feature ofthe loan agreement was deemed to be an embedded derivative instrument requiringseparate accounting under SFAS No. 133, *Accountingfor Derivative Instruments and Hedging Activities*, and was initiallyvalued at $62,000. The derivative asset is being amortized as interest expenseover a term beginning with the loan agreement effective date and ending withthe currently expected payment date of the retroactive interest. The fair valueof the derivative liability is re-measured at each reporting period, with anychange in value charged or credited to interest expense. There was no change in the estimated fair value of thederivative liability at September 30, 2008.

 

FASB Statement No. 157 *Fair ValueMeasurements* (“SFAS No. 157”) establishes a three-tier fair valuehierarchy, which classifies the inputs used in measuring fair value. Thesetiers include: Level 1, defined as observable inputs such as quoted prices foridentical instruments in active markets; Level 2, defined as inputs other thanquoted prices in active markets that are either directly or indirectlyobservable; and Level 3, defined as unobservable inputs for which little or nomarket data exists, therefore requiring an entity to develop its ownassumptions. The fair value of the derivative liability is determined utilizinga model which is classified as  Level 3under SFAS No. 157.

 

***Amounts Due Under Intellectual Property Agreements***

*** ***

Under the Company’s amended patent transfer agreement with Schering, a$1.8 million payment is due in May 2009. Under the Company’s amended license agreement with GE, the Company isscheduled to make a $4.6 million payment (plus interest) in October 

 

12

----

Table of Contents

 

2009.  See “Footnote 6.Intellectual Property”.  Under theCompany’s patent license agreement with Bracco, as amended on July 29,2008, the Company was obligated to make a payment of Euros 500,000(approximately $0.8 million) to Bracco within five business days after theacceptance by the FDA of a new drug application filing package forImagify.  The FDA accepted the Company’sapplication on June  30, 2008, making such payment to Bracco due on July 8,2008.  The amendment reduced the amountof the payment due on July 8, 2008 to Euros 100,000 (approximately $0.2million), and provides that an additional payment of Euros 400,000(approximately $0.6 million) will be due on the first anniversary of suchacceptance by the FDA, or June 30, 2009.

 

As of September 30, 2008, the Company has included the currentcarrying value of the $6.1 million in the current portion of long-termobligations, representing payments due under the GE and Schering agreementswithin the next twelve months.  TheCompany has included the $0.6 million due under the Bracco agreement in currentliabilities.

 

***Operating Leases***

 

Lease expense for the Company’s real estate leases, which generallyhave escalating lease payments over the term of the leases, is recorded on astraight-line basis over the lease term, as defined in SFAS No. 13, *“Accounting for Leases”*. The difference between the expenserecorded in the consolidated statements of operations and the amount paid isrecorded as deferred rent and is included in the consolidated balance sheets.

 

**8. Stockholders’ (Deficit)/Equity**

** **

***ConvertibleExchangeable Preferred Stock***

*** ***

On February 24, 2005, the Company issued 900,000shares of 6.5% convertible exchangeable preferred stock (the “Preferred Stock”)at $50.00 per share resulting in aggregate gross proceeds to the Company of$45.0 million (net proceeds of approximately $41.9 million after deductingunderwriting discounts, commissions and offering expenses). Each share ofPreferred Stock has a liquidation preference of $50.00 per share. Dividends onthe Preferred Stock are cumulative from the date of original issue at theannual rate of $3.25 per share, payable quarterly on the first day of March,June, September, and December. Any dividends must be declared by the Company’sboard of directors and must come from funds that are legally available fordividend payments. As of September 30,2008, dividends accumulated on the Preferred Stock totaled $8.4 million, ofwhich $7.3 million have been paid in cash or issuance of common stock.

 

In February 2008 and May 2008, the Company’sBoard of Directors did not declare the quarterly cash dividend on the preferredstock, payable on March 1, 2008 and June 1, 2008, respectively.  On August 30, 2008, the Board ofDirectors of the Company again elected not to declare a quarterly cash dividendin the amount of $0.8125 per share on the preferred stock that was otherwisepayable on September 1, 2008. This is the third quarterly dividend thathas not been declared and paid on the preferred stock.  Under the terms ofthe preferred stock, the holders thereof shall be entitled to vote as aseparate class to elect two directors if the Company has not paid theequivalent of six or more quarterly dividends, whether or not consecutive.These voting rights will continue until the Company pays the full accrued butunpaid dividends on the preferred stock. The dividend payable on September 1, 2008, which would have totaled$0.4 million in the aggregate, has been included in current liabilities as of September 30,2008.  Currently, there is a balance incurrent liabilities for total dividends payable as of September 30, 2008of approximately $0.8 million.

 

The Preferred Stock is convertible into the Company’s common stock atany time at the option of the holder at a conversion rate of 7.2886 shares ofcommon stock for each share of Preferred Stock, based on an initial conversionprice of $6.86 per share. The initial conversion price is subject to adjustmentin certain events, but is not subject to “price based” anti-dilutionadjustment. The Company has reserved approximately 3.5 million shares of commonstock for issuance upon such conversion.

 

The Company may elect to automatically convert some or all of thePreferred Stock into shares of common stock if the closing price of the Company’scommon stock has exceeded $10.30 per share (150% of the conversion price) forat least 20 trading days during any 30-day trading period, ending within fivetrading days prior to notice of automatic conversion. Prior to March 1,2009, if the Company elects to automatically convert, or if any holder electsto voluntarily convert, the Preferred Stock, the Company will also make anadditional payment (“Make-Whole” payment) equal to the aggregate amount ofdividends that would have been payable on the Preferred Stock so converted fromthe original date of issuance through and including March 1, 2009, lessany dividends already paid on the Preferred Stock. This additional payment ispayable by the Company, at its option, in cash, in additional shares of itscommon stock, or in a combination of cash and shares of common stock. TheCompany has reserved a maximum of approximately 0.3 million shares of commonstock for issuance under this Make-Whole provision.

 

In August 2008, one stockholder voluntarily converted 170,000shares of Preferred Stock into 1,239,066 shares of the Company’s commonstock.  In connection with the conversion,the Company issued an additional 115,682 shares of the Company’s common stockin satisfaction of the required Make-Whole payment.

 

13

----

Table of Contents

 

In February 2008, one stockholder voluntarily converted 40,000shares of Preferred Stock into 291,545 shares of the Company’s commonstock.  In connection with theconversion, the Company issued an additional 27,219 shares of the Company’scommon stock in satisfaction of the required Make-Whole payment.

 

From February 2005 through September 30, 2008, 420,000 shares ofPreferred Stock have been voluntarily converted into 3,061,223 shares of theCompany’s common stock. In connection with such conversions, the Company issuedan additional 490,504 shares of the Company’s common stock in satisfaction ofthe required Make-Whole payment. The fair valueof these Make-Whole payments was approximately $1.8 million, which was chargedagainst the derivative liability.

 

In accordance with SFAS No. 133, the Company is required toseparate and account for as an embedded derivative, the dividend make-wholepayment feature of the Preferred Stock offering. As an embedded derivativeinstrument, the dividend make-whole payment feature must be measured at fairvalue and reflected as a liability. Changes in the fair value of theoutstanding portion of the derivative are recognized in earnings as unrealizedgain or loss on derivative in the statement of operations. The Companydetermined the fair value of the dividend make-whole payment feature to be $3.1million at February 24, 2005 (the commitment date). This amount wasallocated from the proceeds of the Preferred Stock to the derivative liability.At September 30, 2008, the derivative liability was valued at $64,000 andat December 31, 2007, the fair value was $13,000. The fair value of thederivative liability is determined utilizing a model which is classifiedas  Level 3 under SFAS No. 157.

 

The Company may elect to redeem the Preferred Stock at decliningredemption prices on or after March 6, 2009.

 

The Preferred Stock is exchangeable, in whole but not in part, at theoption of the Company on any dividend payment date for the Company’s 6.5%convertible subordinated debentures (“Debentures”) at the rate of $50 principalamount of Debentures for each share of Preferred Stock. The Debentures, ifissued, will mature 25 years after the Exchange Date and have termssubstantially similar to those of the Preferred Stock.

 

The Preferred Stock has no maturity date and no voting rights prior toconversion into common stock, except under limited circumstances.

 

***Common Stock***

*** ***

As of September 30, 2008, there were 98.5 million shares of commonstock authorized, 48.1 million shares of common stock outstanding and 22.8million shares of common stock reserved for issuances, representing 3.5 millionshares reserved for issuance in connection with outstanding convertibleexchangeable preferred stock, 0.3 million shares reserved for issuance inconnection with the make-whole payments provisions of the outstandingconvertible exchangeable preferred stock, 8.8 million shares reserved forissuance in connection with outstanding common stock warrants, 6.7 millionshares reserved for issuance in connection with outstanding stock options, 3.3million shares reserved for issuance, in aggregate, in connection with sharesavailable for future stock or option grants under the 2003 Stock Option Planand Amended 2005 Stock Option Plan, and 0.2 million shares reserved forissuance under the Employee Stock Purchase Plan.

 

**9. Common Stock Warrants**

** **

As of September 30, 2008, warrants to purchase shares of theCompany’s common stock, the origination of which were derived in connectionwith debt and lease financing transactions, the collaborative agreement withNycomed and the April 2006, December 2006 and June 2007 commonstock offerings, were outstanding for an aggregate of 8,776,432 shares ofcommon stock at an effective weighted average price of $4.39 per share asfollows:

 
| **Number of** | ** ** | **Exercise Price** | ** ** | **Expiration**         | ** ** |
|--------------------|------------|-------------------------|------------|------------------------|------------|
| **Shares**         | ** ** | **Per Share**      | ** ** | **Date**               | ** ** |
| 16,212             |       | 19.80                   |       | October 16, 2008  |       |
| 14,934             |       | 19.80                   |       | October 19, 2008  |       |
| 114,895            |       | 8.50                    |       | October 20, 2008  |       |
| 55,732             |       | 6.28                    |       | November 30, 2009 |       |
| 2,688              |       | 19.80                   |       | January 5, 2010   |       |

 

14

----

Table of Contents

 
| 30,844    |   | 28.50 |   | March 30, 2011     |   |
|-----------|--------|-------|--------|-------------------------|--------|
| 28,138    |   | 28.50 |   | September 27, 2011 |   |
| 1,731,600 |   | 7.97  |   | April 12, 2011     |   |
| 3,703,701 |   | 3.11  |   | December 12, 2011  |   |
| 3,077,688 |   | 3.10  |   | June 15, 2012      |   |
| 8,776,432 |   | $     | 4.39   |                    |   |   |
|           |        |       |        |                         |        |  |

 

**10.Related Party Transaction**

** **

On March 28, 2008, the Company entered into a license agreementwith Cephalon providing Cephalon with an exclusive, worldwide license to theCompany’s Hydrophobic Drug Delivery System (HDDS) for oncology applications,along with the rights to AI-850, the Company’s formulation of paclitaxel, inexchange for a cash payment of $10.0 million, paid upon the execution of theagreement.  The term of the agreement extends until expiration of the lastof the patents licensed under the agreement. The Chairman, founder and CEO of Cephalon is also the current PresidingDirector of the Board of Directors of the Company. Martyn Greenacre is a member of the Board of Directors ofboth the Company and Cephalon. As of September 30, 2008,approximately $0.8 million is included in current portion of deferred revenueand approximately $8.9 million is included in the long-term deferredrevenue.  In addition, the Companyrecognized approximately $0.2 million and $0.3 million, respectively, for thethree and nine months ended September 30, 2008 of revenue associated withthis agreement.

 

**11. NewAccounting Pronouncements**

** **

In September 2006, the FASB issued SFAS (SFAS) No. 157, *Fair Value Measurements*, which iseffective for financial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years. The purpose of FAS No.157is to clarify and set forth consistent rules for defining fair value,establishing a framework for measuring fair value in generally acceptedaccounting principles and expanding disclosures about fair value measurements. SFASNo.157 applies under other accounting pronouncements that require or permitfair value measurements where those accounting pronouncements have determinedthat fair value is the relevant measurement attribute. SFAS No. 157 does notrequire any new fair value measurements, but for some entities the applicationof SFAS No. 157 could change current practice. Except as described below, we have adopted SFAS No. 157 on January 1,2008. The adoption of SFAS No. 157 did not have a material impact on theCompany’s financial statements or disclosures.

 

In February 2008, FASB issued FASB FSP FAS 157-2, *Effective Date of FASB Statement No. 157* (FSP 157-2).FSP 157-2 will provide a one-year deferral of the effective date of SFAS No. 157for non-financial assets and non-financial liabilities, except those that arerecognized or disclosed in financial statements at fair value at leastannually. For non-financial assets and non-financial liabilities subject to thedeferral, SFAS No. 157 will be effective in fiscal years beginning after November 15,2008 and in interim periods within those fiscal years. The Company is currentlyevaluating the impact that applying FAS No. 157 to nonfinancial assets andliabilities will have on its consolidatedfinancial statements.

 

In February 2007, the FASB issued SFAS No. 159, *The Fair Value Option for Financial Assets and Financial Liabilities,* which is effective as of thebeginning of an entity’s first fiscal year beginning after November 15,2007.  This statement allows themeasurement at fair value of financial instruments and certain other items thatare currently not required to be measured at fair value. The objective of SFASNo. 159 is to improve financial reporting by providing entities with theopportunity to mitigate volatility in reported earnings caused by measuringrelated assets and liabilities differently without having to apply complexhedge accounting provisions. The fair value option established by this statementpermits the measurement of eligible items at fair value at specified electiondates, with unrealized gains and losses on the items for which the fair valueoption has been elected reported in earnings at each subsequent reportingdate.  SFAS No. 159 was effectivefor the Company in the first quarter of 2008. The adoption of SFAS No. 159did not have an impact on the Company’s financial statements or condition asthey did not elect to use fair value measurements on any assets or liabilitiesunder this statement and have not subsequently elected to carry any assets orliabilities at fair value.

 

In June 2007, the Emerging Issues Task Force issued EITF 07-3, *Accounting for Nonrefundable Advance Payments for Goods or ServicesReceived for Use in Future Research and Development Activities*, which is effective as of thebeginning of an entity’s first fiscal year beginning after December 15,2007.  This abstract discusses thetreatment of the nonrefundable portion of advance payments made pursuant to anexecutory contractual arrangement for future research and developmentactivities.  Nonrefundable advancepayments for goods or services that will be used or rendered for futureresearch and development activities should be deferred and capitalized. Suchamounts should be recognized as an expense as the related goods are deliveredor the related services are performed. If an entity does not expect the goodsto be delivered or services to be rendered, the capitalized advance paymentshould be charged to expense.  TheCompany adopted this statement as of January 1, 2008 and concluded it hasno effect on its consolidated financial statements.

 

15

----

Table of Contents

 

In March 2008, the FASB issuedSFAS No. 161, an amendment of SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities,* which is effective as of thebeginning of an entity’s first fiscal year beginning after November 15,2008.  This Statement changes the disclosure requirements for derivativeinstruments and hedging activities, requiring enhanced disclosures about (a) howand why an entity uses derivative instruments, (b) how derivativeinstruments and related hedged items are accounted for under Statement 133 andits related interpretations, and (c) how derivative instruments and relatedhedged items affect an entity’s financial position, financial performance, andcash flows.  The Company isassessing the impact, if any, of this pronouncement on its consolidatedfinancial statements.

 

**12. Subsequent Events**

** **

On November 3, 2008 the Company closed a transaction with Cephalonto provide $20 million in upfront funding to the Company.  Cephalon purchased a $15 million seniorsecured convertible note (the “Cephalon Note”) and paid a $5 million upfrontfee for an exclusive worldwide license to AI-525, a preclinical-stageinjectable formulation of celecoxib using the Company’s proprietary HydrophobicDrug Delivery System (HDDSTM) technology (the “Celecoxib License”).    The terms of the Celecoxib License alsoinclude a milestone payment of $15 million upon the receipt from the US Foodand Drug Administration (“FDA”) of final approval of the first New DrugApplication or NDA with respect to celecoxib for any indication, and certainroyalty payments based on future sales by Cephalon of celecoxib.  Thetransaction with Cephalon described in this Note 12 shall be referred to collectivelyas the “Cephalon Transaction”.  TheChairman, founder and CEO of Cephalon is also the current Presiding Director ofthe Board of Directors of the Company. Martyn Greenacre is a member of the Board of Directors ofboth the Company and Cephalon.

 

The Cephalon Note includes an annual interest rate of 8.0% payableannually over three years in cash or shares of the Company’s common stock atthe Company’s election. The Cephalon Note is secured by certain assets of theCompany, including all of the Company’s intellectual property, pursuant to theterms of a Pledge and Security Agreement with Cephalon.  The Cephalon Noteis subject to acceleration and an increased interest rate of 15% upon thehappening of customary events of default, including the failure to make timelypayments of principal and interest.

 

The Cephalon Note is convertible at Cephalon’s option any time prior toNovember 3, 2009 into one of the following: (i) the greater of (A) thenumber of shares of the Company’s common stock equal to $15 million divided by90% of $0.486 (subject to certain adjustments as provided in the Cephalon Note)or (B) the number of shares of the Company’s common stock equal to 51% ofthe Company’s outstanding common stock on a fully-diluted basis as calculatedas set forth in the Cephalon Note on the date of conversion of the CephalonNote, (ii) the right to enter into an exclusive license to allintellectual property rights of the Company relating to ImagifyTM (PerflubutanePolymer Microspheres) for Injectable Suspension (the “Imagify License”) to use,distribute and sell Imagify for all current and future indications includingcoronary heart disease, in a worldwide territory, excluding those Europeancountries for which Nycomed Danmark ApS has rights pursuant to that certainCollaboration, License and Supply Agreement dated as of July 6, 2004, asamended, or (iii) the satisfaction of Cephalon’s obligation to pay theCompany the $15 million milestone payment for approval of the injectableformulation of celecoxib by the FDA for any indication pursuant to theCelecoxib License  In connection with the possible conversion of theCephalon Note into shares of the Company’s common stock, the Company has alsoentered into a registration rights agreement with Cephalon pursuant to whichthe Company has agreed to register for resale shares of the Company’s commonstock held by Cephalon.

 

If Cephalon elects to convert the Cephalon Note into the right to enterinto the Imagify License, the Company is entitled to a $40 million regulatorymilestone payment upon final FDA approval of the first NDA for Imagify for thedetection of coronary artery disease and certain royalty payments based onfuture sales by Cephalon of Imagify. The term of the Imagify License wouldextend until the expiration of the last of the patent rights licensed undersuch agreement.

 

The Cephalon Note was issued pursuant to a Note Purchase Agreementbetween the Company and Cephalon (the “Note Purchase Agreement”), whichprovides for customary representations and warranties and covenants regardingthe conduct of the Company’s business for so long as the Cephalon Note remainsoutstanding or Cephalon holds at least 25% or more of the Company’s outstandingvoting securities (the “Restricted Period”).  The Company has also grantedCephalon preemptive rights during the Restricted Period.  In addition,from and after the conversion of the Cephalon Note and for so long as Cephalonholds at least 25% or more of the Company’s outstanding voting securities, Cephalonwill have the right to designate that number of directors to the Company’s Boardof Directors that is proportional to its equity interest, provided that anyfuture transaction between the Company and Cephalon must be approved by acommittee of directors consisting entirely of directors that are independent ofCephalon.

 

In connection with Cephalon Transaction, and pursuant to thestockholder approval received at the Company’s annual meeting of stockholderson June 5, 2008, the Company filed on October 31, 2008 an amendmentto its certificate of incorporation with the 

 

16

----

Table of Contents

 

Secretary of State of the State of Delaware increasing the authorizednumber of shares of its common stock from 98.5 million to 250 million shares.

 

In October 2008, two stockholders voluntarily converted, in theaggregate, 170,000 shares of Preferred Stock into 1,239,066 shares of theCompany’s common stock.  In connectionwith the conversion, the Company issued an additional 115,682 shares of theCompany’s common stock in satisfaction of the required Make-Whole payment.

 

17

----

Table ofContents

 

**ITEM 2. MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

*Statementscontained herein, including without limitation, “Management’s Discussion andAnalysis of Financial Condition and Results of Operation,” contains certainprojections, estimates and other forward-looking statements. “Forward-lookingstatements,” as that term is defined in the Private Securities LitigationReform Act of 1995, are not historical facts and involve a number of risks anduncertainties. Words herein such as “may,” “will,” “should,” “could,” “would,” “expects,”“plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “intends,”“potential,” and similar expressions (as well as other words or expressionsreferencing future events, conditions or circumstances) are intended toidentify forward-looking statements.*

 

*Forward-lookingstatements include, but are not limited to: our capital requirements and ourneeds for additional financing; the timing and level of future expenses,revenues and profitability; the timing of these development programs, inparticular our estimates of the timing of an MAA for Imagify; the timing andlikelihood of regulatory approval of an NDA and MAA for Imagify; the level ofclinical and commercial interest in Imagify; the required size and make-up of asales force to effectively launch Imagify; our development of other productcandidates; our ability to qualify a commercial manufacturing facility forImagify; our estimates of the size of the potential markets for our productcandidates; our selection and licensing of product candidates; our ability toattract and retain collaborators with acceptable development, regulatory andcommercialization expertise; the benefits to be derived from corporatecollaborations, license agreements and other collaborative efforts, includingthose relating to the development and commercialization of our productcandidates; sources of revenues and anticipated revenues, includingcontributions from corporate collaborations, license agreements and othercollaborative efforts for the development and commercialization of products;our ability to create an effective direct sales and marketing infrastructurefor products we elect to market and sell directly; the rate and degree ofmarket acceptance of our product candidates; the timing and amount ofreimbursement for our product candidates; the success and timing of othercompeting therapies that are or may become available; and the manufacturingcapacity for our product candidates.*

 

*Ouractual results and the timing of certain events may differ materially from theresults discussed, projected, anticipated or indicated in any forward-lookingstatements. Any forward-looking statement should be considered in light offactors discussed in Part II. Item 1A “Risk Factors” and elsewhere in thisreport. We caution readers not to place undue reliance on any suchforward-looking statement, which speak only as of the date they are made. Wedisclaim any obligation, except as specifically required by law and the rules ofthe Securities and Exchange Commission, to publicly update or revise any suchstatements to reflect any change in company expectations or in events,conditions or circumstances on which any such statements may be based, or thatmay affect the likelihood that actual results will differ from those set forthin the forward-looking statements.*

 

*Thefollowing discussion should be read in conjunction with our consolidatedfinancial statements and related notes thereto included elsewhere in this Form 10-Qand with our Annual Report on Form 10-K.*

 

**Overview**

 

We are a specialtypharmaceutical company that develops new drugs and improved formulations ofexisting drugs using our proprietary porous microparticle technology. We arefocused on developing proprietary drugs that can offer significant benefitssuch as improved safety and efficacy, increased patient compliance, greaterease of use, expanded indications or reduced cost. Our lead product candidate, ImagifyTM (perflubutane polymer microspheres),is a cardiovascular drug for the detection of coronary artery disease,the leading cause of death in the United States.  We submitted our new drug application (“NDA”)for Imagify in April 2008 and the NDA was accepted by the FDA for reviewon June 30, 2008.  The FDAacceptance of the NDA submission indicates that the application is sufficientlycomplete to permit a substantive review and meets the threshold for filing.With a standard review, under the FDA Prescription Drug User Fee Act (PDUFA),the target action date is 10 months from the submission date, or February 28,2009.   The FDA has published a FederalRegister Notice on the FDA website of a planned public meeting of theCardiovascular and Renal Drugs Advisory Committee on December 10, 2008,the agenda of which includes a review of Imagify.  In Europe, we have entered into acollaboration agreement with Nycomed for the marketing and sale ofImagify.  Nycomed is responsible for thefiling of a Marketing Authorization Application (“MAA”) for Imagify inEurope.  Nycomed’s filing of the EuropeanMAA is now planned for 2009.   Inaddition to our progress with Imagify, wehave demonstrated that our technology can improve the formulation ofhydrophobic drugs and inhaled asthma drugs.

 

We believe thatImagify perfusion ultrasound has the potential to significantly reduce thetime, cost and resources needed in the assessment of myocardial perfusion,compared to nuclear stress testing, without subjecting patients to radiation.Myocardial perfusion is blood flow to the heart muscle, a sensitive marker forcoronary artery disease.  There is no ultrasound imaging agent currently 

 

18

----

Table ofContents

 

approved by FDAfor use in cardiac ultrasound for myocardial perfusion imaging or for any otherindication in conjunction with cardiac stress ultrasound.

 

We developedImagify and our other product candidates using our proprietary technology whichenables us to control the size and porosity of particles, includingnanoparticles and microparticles, in a versatile manner, so we can customizethe particles to address the delivery needs of a variety of drugs. We arefocused on creating porous microparticles that are smaller than red bloodcells. Some of these microparticles are nanoparticles which are smaller thanone micron. Small microparticles are important for delivering drugsintravenously so that they can pass through the body’s smallest blood vessels,for increasing the surface area of a drug so that the drug will dissolve morerapidly, and for delivering drugs to the lung via inhalation. Porosity is importantfor entrapping gases in microparticles, for controlling the release rate of thedrug from a microparticle, and for targeting inhaled drugs to specific regionsof the lung.

 

We have incurredsignificant operating losses to develop our product candidates and weanticipate continuing to incur significant operating losses in the comingyears. In particular, we expect to incur significant additional expenses andexperience other significant capital requirements to seek regulatory approvalfor Imagify, to complete the qualification of a manufacturing facility for theinitial commercial manufacture of Imagify and, subject to regulatory approvals,to launch Imagify. Since our inception, we have funded our operations primarilythrough private and public placements of equity securities, equipment-backedfinancings and other debt financings.  AtSeptember 30, 2008, we had approximately $4.1 million in cash and cashequivalents.  With the proceeds receivedfrom the Cephalon transaction on November 3, 2008 and based on our currentoperating plans, we will require significant additional capital to fund ouroperations through and beyond the second quarter of 2009.

 

**Imagify Phase 3 Clinical Trials**

 

We have completedtwo Phase 3 pivotal clinical trials for Imagify and have submitted an NDAseeking approval to market and sell Imagify. These two pivotal trials, named RAMP-1 and RAMP-2, respectively, wereindependent multi-center pivotal trials conducted at clinical sites primarily locatedin North America and Europe. “RAMP” stands for Real-time Assessmentof Myocardial Perfusion with echocardiography. Datafrom the Phase 3 pivotal studies are intended for submission to U.S., European,and potentially other regulatory authorities.

 

There were threedifferent ultrasound readers in each of RAMP-1 and RAMP-2 (six readers intotal). All three readers demonstrated non-inferiority to nuclear stress withrespect to the principal primary endpoint of accuracy.  In the RAMP-1 trial, the trial with therelatively lower risk patient population, the ultrasound blinded readersdemonstrated superior specificity (themeasure of effectiveness in assessing the absence of disease) comparedto nuclear stress. In the RAMP-2 trial, the trial with the relatively higherrisk patient population, the ultrasound blinded readers demonstrated superiorsensitivity (the measure ofeffectiveness in assessing disease) compared to nuclear stress. We demonstratedsuperior specificity in RAMP-1 and superior sensitivity in RAMP-2.  Only one of the three ultrasound blindedreaders demonstrated non-inferiority to nuclear stress for sensitivity inRAMP-1, and only one of the three ultrasound blinded readers demonstratednon-inferiority to nuclear stress for specificity in RAMP-2.  We believe that the missed component primaryendpoints in these trials was due largely to the inherent trade-off betweensensitivity and specificity caused by “aggressive” and “conservative”ultrasound and nuclear readers. While these component primary endpoints weremissed, we believe that both trials demonstrated that, overall, Imagifyperfusion stress ultrasound is just as accurate as nuclear stress across allreaders. We also believe that because, in addition to achieving the principalprimary endpoint in both trials, Imagify perfusion stress ultrasound alsodemonstrated superior results on component primary endpoints which we believewere the most important in each of these trials (specificity in the lower riskpatient population and sensitivity in the higher risk patient population).

 

We submitted anNDA for Imagify in April 2008 and the NDA was accepted by the FDA forreview on June 30, 2008.  The FDAacceptance of the NDA submission indicates that the application is sufficientlycomplete to permit a substantive review and meets the threshold for filing.With a standard review, under the FDA Prescription Drug User Fee Act (PDUFA),the target action date is 10 months from the submission date, or February 28,2009.  The FDA has published a FederalRegister Notice on the FDA website of a planned public meeting of theCardiovascular and Renal Drugs Advisory Committee on December 10, 2008,the agenda of which includes a review of Imagify.

 

The discussion ofour NDA submission and likelihood of success reflects our current assumptions,based on our knowledge and experience and the guidance of our advisors. We cannot assure you that timelines will be met, nor can we assure you that ourestimates and assumptions will not change based upon ongoing regulatoryfeedback or that FDA will approve our NDA. We cannot control nor predict the timing or extent, if any, of FDAapproval of Imagify.  Nycomed isresponsible for the submission of Imagify for approval in Europe. Nycomed’s  filing of the MAA for Imagify is currentlyplanned for 2009 due to negative opinion from the 

 

19

----

Table ofContents

 

European MedicinesAgency (“EMEA”) on pediatric wavier. Recently enacted European legislation requires applicants to provide aplan for the conduct of pediatric studies (Pediatric Investigational Plan) forall new drugs or obtain a waiver for such requirement before a MAA filingis accepted by EMEA.  Nycomed’s initialrequest for a pediatric waiver was denied by the EMEA.  We cannot control nor predict the timing orextent, if any, of Imagify approval in Europe or elsewhere.

 

**Imagify Manufacturing Facility Update**

 

As part of our NDAsubmission for Imagify, we have demonstrated that we can manufacture Imagify atcommercial scale and have validated the process in accordance with Europeanregulatory requirements.

 

In late 2005 wesubstantially completed the build-out of a 58,000 square foot commercialmanufacturing facility in Tewksbury, Massachusetts.  In 2006 we completed commissioning of themanufacturing equipment and utilities, produced full commercial scaledevelopment batches of Imagify and substantially completed all InstallationQualification, or IQ, and Operational Qualification, or OQ, requirementsrelating to the equipment and utilities initially needed for thisfacility.  In 2007, we continued to makeprogress on the remaining steps toward the qualification of the manufacturingfacility, with aseptic validation completed in early 2008.  We have completed the process validationbatches in preparation for Nycomed’s MAA submission in Europe.  Data from the production of Imagify atcommercial scale and the aseptic validation data were included in our NDAsubmission of Imagify.  We believe thatour existing facilities are adequate to meet our current and initial projectedcommercial requirements and that suitable space will be available as needed. Weare currently preparing our manufacturing facility for a Pre-ApprovalInspection to be conducted by the FDA prior to the PDUFA date in late 2008 orearly 2009.

 

**Operational Activities Update**

 

Our currentoperational activities include:

 

*NDA/MAA*:  We completed aseptic validation in early2008.  We submitted our NDA for Imagifywith FDA in April 2008 and the NDA was accepted by the FDA for review on June 30,2008.  The FDA acceptance of the NDAsubmission indicates that the application is sufficiently complete to permit asubstantive review and meets the threshold for filing. With a standard review,under the FDA Prescription Drug User Fee Act (PDUFA), the target action date is10 months from the submission date, or February 28, 2009 which we refer toas our “PDUFA Date”.  We submitted theNDA in electronic CTD format, which can also be utilized for submission inEurope, and are currently responding to FDA questions arising from their reviewof the NDA and preparing for the FDA Cardiovascular and Renal Drugs AdvisoryCommittee meeting on December 10, 2008.  We are currently preparing our manufacturing facility for a Pre-ApprovalInspection to be conducted by FDA prior to the PDUFA date in late 2008 or early2009.  We have completed the processvalidation batches in preparation for the MAA submission by Nycomed, ourEuropean partner.  Nycomed’s filing of theEuropean MAA is currently planned for 2009.

 

*Preparationsfor Commercialization of Imagify After the PDUFA date*: Weplan to conduct market research and advance our plans for the commercial launchof Imagify, including conducting various clinical trials designed to supportthe commercialization of Imagify.

 

*Publicationof Imagify Results*: In November 2007 we presented datafrom the RAMP-1 and RAMP-2 clinical trials at the annual American HeartAssociation meeting in Orlando, Florida and in December 2007, at EuroECHO2007 in Lisbon, Portugal. We will continue to work with the clinicalinvestigators to publish further data on our clinical trial results.

 

*Agreementswith Cephalon:*In March 2008 we entered into a licenseagreement with Cephalon, Inc. or Cephalon providing Cephalon with anexclusive, worldwide license to our Hydrophobic Drug Delivery System (HDDS) foroncology applications, along with the rights to AI-850, our patentedformulation of paclitaxel, in exchange for a cash payment of $10.0 million. The term of this license agreement extends until the expiration of the last ofthe patent rights licensed under this agreement.  This product development candidate, AI-850, and AbraxaneTM, a registeredtrademark of Abraxis Bioscience, Inc., have comparable pharmacokineticprofiles based upon human data available in publications on each drug.  AI-850 is our patented formulation ofpaclitaxel, the active ingredient in AbraxaneTM. Drug product candidatesthat are confirmed to have equivalent pharmacokinetics in a human study may beeligible for regulatory approval as a bioequivalent and the development timeline is accelerated, sincePhase 2 and Phase 3 human clinical trials are not required.

 

In November 2008,we entered into a license agreement with Cephalon providing Cephalon with anexclusive worldwide license to AI-525, a preclinical-stage injectableformulation of celecoxib using our proprietary Hydrophobic Drug Delivery System(HDDSTM) 

 

20

----

Table ofContents

 

technology, inexchange for an upfront cash payment of $5 million, a milestone payment of $15million upon our receipt from the FDA of final approval of the first New DrugApplication or NDA prepared by us with respect to celecoxib for any indication,and certain royalty payments based on future sales by Cephalon of celecoxib.The term of this license agreement extends until the expiration of the last ofthe patent rights licensed under the agreement.

 

In connection withthis November 2008 transaction we issued Cephalon a $15 million seniorsecured convertible note pursuant to a note purchase agreement, which agreementprovides Cephalon with preemptive rights on future equity issuances byAcusphere as well as certain restrictive covenants regarding the conduct of ourbusiness, in each case for so long as the Cephalon convertible note remainsoutstanding or Cephalon holds at least 25% or more of our outstanding votingsecurities, which period we refer to as the restricted period.  Inaddition, from and after the conversion of the Cephalon convertible note andfor so long as Cephalon holds at least 25% or more of our outstanding votingsecurities, Cephalon will have the right to designate that number of directorsto our board of directors that is proportional to its equity interest, providedthat any future transaction between us and Cephalon must be approved by acommittee of directors consisting entirely of directors that are independent ofCephalon.

 

The Cephalonconvertible note includes an annual interest rate of 8.0% payable annually overthree years in cash or shares of our common stock at our election.  The Cephalon convertible note is secured bycertain of our assets, including all of our intellectual property.  TheCephalon convertible note is subject to acceleration and an increased interestrate upon the happening of customary events of default, including the failureto make timely payments of principal and interest.

 

The Cephalonconvertible note is convertible at Cephalon’s option any time prior to November 3,2009 into one of the following: (i) the greater of (A) the number ofshares of our common stock equal to $15 million divided by 90% of $.486(subject to customary adjustments for stock splits and similar events) or (B) thenumber of shares of our common stock equal to 51% of our outstanding commonstock on a fully-diluted basis on the date of conversion of the Cephalonconvertible note, (ii) the right to enter into an exclusive license to allof our intellectual property rights relating to Imagify to use, distribute andsell Imagify for all current and future indications including coronary heartdisease, in a worldwide territory, excluding those European countries for whichNycomed has rights pursuant to our collaboration agreement with Nycomed, or (iii) thesatisfaction of Cephalon’s obligation to pay us the $15 million milestonepayment for approval of celecoxib by the FDA for any indication pursuant to thecelecoxib license agreement described above.  In connection with thepossible conversion of the Cephalon convertible note into shares of our commonstock, we also entered into a registration rights agreement with Cephalonpursuant to which we have agreed to register for resale shares of our commonstock held by Cephalon.

 

If Cephalon electsto convert the Cephalon convertible note into the right to enter into theImagify license, we will be entitled to a $40 million regulatory milestonepayment upon final FDA approval of the first NDA for Imagify for the detectionof coronary artery disease and certain royalty payments based on future salesby Cephalon of Imagify. The term of the Imagify would extend until theexpiration of the last of the patent rights licensed under such agreement.

 

In addition, ifCephalon elects to convert the Cephalon convertible note into the right toenter into the Imagify license, it may elect to manufacture Imagify itself orit may require Acusphere to manufacture Imagify at a cost no greater than ouractual fully burdened manufacturing cost.

 

Although we are working towardsthe achievement of these operational objectives, there can be no assurance thatwe will successfully achieve these objectives in a timely or successful manner,or that they will be achieved at all. In particular, in light of our currentcapital constraints and need to preserve capital to fund operations, ourability to achieve these operational objectives will be adversely affectedunless and until we are able to obtain additional financing.

 

**EuropeanCollaboration Agreement**

 

In July 2004,we entered into a collaboration, license and supply agreement with Nycomedpursuant to which we granted Nycomed rights to develop and market Imagify inEurope. As part of the agreement, Nycomed agreed to provide up to$70.0 million in license fees, research and development funding, andmilestone payments, of which $12.0 million for research and developmenthas been received.  In October 2005and February 2006, we amended the agreement with Nycomed, and anadditional $2 million was received for trademark and other activitiesassociated with the qualification of our manufacturing facility. In connectionwith our agreement with Nycomed, Nycomed has agreed to pay us to manufactureImagify for them and to pay us royalties on Nycomed’s sales of Imagify. In June 2008,we further amended our agreement again, and Nycomed agreed to reimburse us forexpenses related to our qualification of our commercial manufacturing facilityin Tewksbury, Massachusetts up to $750,000 which shall be credited against 

 

21

----

Table ofContents

 

their initialpurchases of Imagify.  In September 2008, we again amended ouragreement with Nycomed.  This amendmentremoved a contingency associated with $2.0 million worth of additionalpayments.  The payments received pursuantto these amendments are considered advances against future milestone payments,and have been deducted from the $58 million in remaining milestonepayments.  Therefore, we are entitled toreceive $56 million in remaining milestone payments, of which the next paymentis due upon the first commercial sale of Imagify. Nycomed will be responsiblefor sales, marketing and the regulatory submissions required for marketingImagify throughout its sales territory, which includes the member states of theEuropean Union, as well as Russia/CIS Jurisdictions and Turkey.

 

The Nycomedagreement is subject to termination provisions. Under certain of thesetermination provisions, if we fail in any material respect to use allcommercially reasonable efforts to carry out our obligations under theagreement, we would be obligated to pay Nycomed liquidated damages of up to$12.0 million. We believe we have and continue to use all commerciallyreasonable efforts to fulfill our obligations under the agreement, which webelieve are in our control. However, there can be no assurance that terminationof this agreement will not occur or that such termination would not result inus incurring liquidated damages of up to $12.0 million.

 

**FinancialOperations Overview**

 

*Revenue.*    Wehave not generated any revenue from product sales since our inception. Since July 2004,when we entered into our collaboration agreement with Nycomed, the majority ofour revenue has been collaboration revenue recognized in connection withresearch and development activities performed under this agreement.  As of September 30, 2008 Nycomed hadpaid us $14.0 million in license fees and for our research and developmentefforts. We are recognizing this $14.0 million of initial license and researchand development payments ratably over a period currently estimated at 66months.  The length of this research anddevelopment period, which is the period over which we are obligated to performservices, is estimated based on available facts and circumstances.  We periodically evaluate the assumptionsunderlying our estimate and change our estimate when appropriate.

 

Under the March 2008intellectual property license agreement with Cephalon, Inc., we received$10.0 million and began recognizing revenue in the second quarter of 2008 overthe remaining term of the agreement, which extends until expiration of the lastof the patents licensed under the agreement, or approximately 13 years.  The Chairman, founder and CEO of Cephalon isalso the current Presiding Director of the Board of Directors of the Company. Martyn Greenacre is a member of the Boardof Directors of both the Company and Cephalon.

 

In the future, wewill seek to generate revenue from a combination of product sales, up-front ormilestone payments and manufacturing payments in connection with collaborativeor strategic relationships, and royalties resulting from the license of ourproducts and intellectual property.

 

*Researchand Development Expense.  * Research and developmentexpense consists of expenses incurred in developing, manufacturing and testingproduct candidates. These expenses consist primarily of salaries and relatedexpenses for personnel, fees paid to professional service providers inconjunction with independently monitoring our clinical trials and acquiring andevaluating data in conjunction with our clinical trials, costs of materialsused in clinical trials and research and development, depreciation of capitalresources used to develop our products, costs of facilities, the legal costs ofpursuing patent protection on select elements of our intellectual property,costs for intellectual property rights we have acquired or licensed andstock-based compensation. We expense research and development costs, includingpatent related costs, as incurred. We believe that significant investment inproduct development is a competitive necessity and plan to continue theseinvestments in order to realize the potential of our product candidates andproprietary technologies. Development programs for later stage productcandidates, such as Imagify, tend to cost more than earlier stage programs dueto the length and the number of patients enrolled in clinical trials for laterstage programs and due to costs of scaling production to commercial scale.

 

*Generaland Administrative Expense.  * General andadministrative expense consists primarily of salaries and other related costsfor personnel in executive, finance, accounting, information technology,business development and human resource functions. Other costs include facilitycosts not otherwise included in research and development expense, professionalfees for legal and accounting services and stock-based compensation.  In addition, we categorize our marketresearch and other marketing-type costs as general and administrative expense becausewe have not yet obtained approval to market or sell our product candidates.

 

*InterestIncome.*    Interest income consists ofinterest earned on our cash and cash equivalents.

 

*InterestExpense.*    Interest expense consistsprimarily of interest incurred on equipment leases, equipment loans and otherfinancing arrangements.

 

22

----

Table ofContents

 

*Changein Valuation of Derivative.  * The terms of our February 2005convertible preferred stock offering and our March 2005 Mass Developmentloan agreement contain features considered to be embedded derivatives which arerecorded at estimated fair value in accordance with Statement of FinancialAccounting Standards No. 133, *Accounting for DerivativeInstruments* (SFAS 133). Changein valuation of derivative consists of other income (expense) recognized on thechange in fair value of the derivative at the end of each reportingperiod.  The change in the value of theembedded derivative related to the preferred stock is affected by a number ofassumptions including the number of preferred shares outstanding, the amount ofdividends paid and the probability and timing of conversion into common stock.The derivative liability is reduced for any make-whole payments made during theperiod upon conversions of preferred stock to common stock. The change in thevalue of the derivative related to the loan is affected by the expected timingof future positive net cash flows from operations.

 

*Dividends on PreferredStock.  * For the nine months ended September 30,2008 and 2007, dividends on preferred stock consisted of dividends paid oraccumulated on the convertible exchangeable preferred stock which we issued in February 2005.Dividends on preferred stock exclude any make-whole payments on conversion ofpreferred stock to common stock. Dividends on our preferred stock arecumulative from the date of original issue at the annual rate of $3.25 pershare, payable quarterly on the first day of March, June, September, andDecember. Any dividend payment must be declared by our board of directors andmust come from funds that are legally available for dividend payments.  In February 2008 and May 2008, our Boardof Directors did not declare the quarterly dividend on the preferred stock,payable on March 1, 2008 and June 1, 2008, respectively. In August 2008,our Board of Directors again elected not to declare a quarterly cash dividendin the amount of $0.8125 per share on the preferred stock that was otherwisepayable on September 1, 2008. This is the third quarterly dividend thathas not been declared and paid on the preferred stock.  Under the terms ofthe preferred stock, the holders thereof shall be entitled to vote as aseparate class to elect two directors if we have not paid the equivalent of sixor more quarterly dividends, whether or not consecutive. These voting rightswill continue until we pay the full accrued but unpaid dividends on thepreferred stock.  The dividend payable onSeptember 1, 2008 totaled $0.4 million in the aggregate.  Cumulative dividends payable of $0.8 millionhave been included in current liabilities as of September 30, 2008.

 

**Results of Operations**

 

*Three Months Ended September 30,2008 and 2007*

 

*Revenue.*   In connection with our collaboration agreement with Nycomed entered into in July 2004,Nycomed has paid us $12.0 million in license fees for our research anddevelopment efforts. We had previously been recognizing this $12.0 million inresearch and development payments ratably over the estimated developmentperiod, as defined, of 54 months. Estimation of this development period involves many assumptions.  We regularly assess these assumptions and ourestimated development recognition period may change if facts and circumstanceschange.  We reevaluated the assumptions underlying the development termand during the three months ended September 30, 2008, modified ourestimate of the development period over which we are obligated to performservices to 66 months.  Collaborationrevenue recognized under this agreement for the three months ended September 30,2008 was approximately $0.2 million and in 2007 was approximately $0.7 million.

 

Under the March 2008intellectual property license agreement with Cephalon, Inc., revenue beganto be recognized in the second quarter of 2008 over the remaining term of theagreement, which extends until expiration of the last of the patents licensedunder the agreement, or approximately 13 years. We recognized revenue for the three months ended September 30, 2008of approximately $0.2 million under this agreement.

 

*Research and Development Expense*.    Research anddevelopment expense for the three months ended September 30, 2008decreased $4.2 million, or 36%, to $7.5 million versus $11.7 million in theprior year period. The decrease was primarily due to lower costs of early stagedevelopment programs as we increase our focus on supporting our Imagify NDA andMAA submissions.

 

The following table summarizes the primary components of ourresearch and development expense for the three months ended September 30,2008 and 2007:

 
| ** **                             | ** ** | **Three Months Ended September  30,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|
| ** **                             | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| ** **                             | ** ** | **(In thousands)**                              | ** ** |
| Imagify                                |       | $                                                    | 3,101      |   | $ | 5,509 |   |
| HDDS and PDDS                          |       | 89                                                   |       | 1,683 |   |
| Other direct costs                     |       | 813                                                  |       | 991 |   |
| Total direct costs                     |       | $                                                    | 4,003      |   | $ | 8,183 |   |
| Indirect costs:                        |       |                                                 |       |   |   |
| Facility rent costs                    |       | 844                                                  |       | 862 |   |
| Depreciation                           |       | 2,476                                                |       | 2,474 |   |
| Other indirect costs                   |       | 180                                                  |       | 209 |   |
| Total indirect costs                   |       | 3,500                                                |       | 3,545 |   |
| Total research and development expense |       | $                                                    | 7,503      |   | $ | 11,728 |   |

 

23

----

Table ofContents

 

*LateStage Clinical Development Program**(Imagify).* Our lead product candidate, Imagify, is a cardiovascular drug designedfor the detection of coronary artery disease. Direct expense for research anddevelopment of Imagify was $3.1 million for the three months ended September 30,2008 versus $5.5 million in 2007. Clinical trial costs relating to Imagify pivotal trials decreased in2008 versus 2007, following the release of RAMP-2 results in May 2007.

 

*EarlyStage Development Programs**(HDDS and PDDS).*  During 2008, we anticipate the costs of earlystage development programs to decrease as we increase our focus on supportingour Imagify NDA and MAA submissions. Because these other programs are in relatively early stages ofdevelopment, we anticipate that costs related to Imagify will continue torepresent our primary research and development expenditures through 2008.

 

*OtherCosts.* Other direct research and development costs primarilyconsist of management and preclinical evaluation of other product candidates.

 

Each of ourresearch and development programs is subject to risks and uncertainties,including the requirement to seek regulatory approvals, which are outside ofour control.  Moreover, the productcandidates identified in these research and development programs, particularlyour early stage programs, must overcome significant technological,manufacturing and marketing challenges before they can be successfullycommercialized. As a result of these risks and uncertainties, we are unable topredict with any certainty the period in which material net cash inflows fromsuch projects could be expected to commence or the completion date of theseprograms. Failure to commercialize these product candidates on a timely basiscould have a material adverse affect on our business, financial condition andresults of operations. We may seek to establish collaborative relationships tohelp us commercialize these product candidates, but there can be no assurancethat we will be successful in doing so.

 

*Generaland Administrative Expense.*    Generaland administrative expense for the three months ended September 30, 2008was $2.8 million, versus $3.1 million in the prior year period, a decrease of$0.3 million or 10%.  The decrease was due to lower consulting costs inmarketing.

 

The followingtable summarizes the primary components of our general and administrativeexpense for the three months ended September 30, 2008 and 2007:

 
| ** **                               | ** ** | **Three Months Ended September  30,** | ** ** |
|------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                               | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| ** **                               | ** ** | **(In thousands)**                              | ** ** |
| Direct costs                             |       | $                                                    | 2,526      |   | $ | 2,910 |   |
| Indirect costs:                          |       |                                                 |       |   |   |
| Facility costs                           |       | 219                                                  |       | 130 |   |
| Depreciation                             |       | 27                                                   |       | 52 |   |
| Total indirect costs                     |       | 246                                                  |       | 182 |   |
| Total general and administrative expense |       | $                                                    | 2,772      |   | $ | 3,092 |   |

 

*InterestIncome.*    Interest income for the threemonths ended September 30, 2008 decreased approximately $0.5 million, or83%, to approximately $0.1 million versus $0.6 million in the prior yearperiod.  The decrease was due to lower average cash balances during theperiod.

 

*InterestExpense.*    Interest expense for thethree months ended September 30, 2008 decreased $0.2 million, or 40%, to$0.3 million versus $0.5 million in the prior year period.   Thedecrease is due to lower average loan balances during the period as a result ofrepayments of the capital equipment loans.

 

24

----

Table ofContents

 

*Changein Valuation of Derivative.* The derivative is related to the embedded derivative instrument from thedividend make-whole payment feature of the preferred stock offering that closedin February 2005. The derivative liability value is reduced as dividendspayments on the preferred stock are made, as well as for any conversions ofpreferred stock into common stock.  Thederivative liability at September 30, 2008 was valued at $64,000.

 

*Nine Months Ended September 30,2008 and 2007*

 

*Revenue.*   In connection with our collaboration agreement with Nycomed entered into in July 2004,Nycomed has paid us $12.0 million in license fees for our research anddevelopment efforts. We had previously been recognizing this $12.0 million inresearch and development payments ratably over the estimated developmentperiod, as defined, of 54 months. Estimation of this development period involves many assumptions.  We regularly assess these assumptions and ourestimated development recognition period may change if facts and circumstanceschange.  We reevaluated the assumptions underlying the development termand during the three months ended September 30, 2008, modified ourestimate of the development period over which we are obligated to performservices to 66 months.  Collaborationrevenue recognized under this agreement for the nine months ended September 30,2008 and 2007 was $1.5 million and $2.0 million, respectively.

 

Under the March 2008intellectual property license agreement with Cephalon, Inc., revenue beganto be amortized in the second quarter of 2008 over the remaining term of theagreement, which extends until expiration of the last of the patents licensedunder the agreement, or approximately 13 years. We recognized revenue for the nine months ended September 30, 2008of approximately $0.3 million under this agreement.

 

*Research and Development Expense*.    Research anddevelopment expense for the nine months ended September 30, 2008 decreased$5.4 million, or 17%, to $27.2 million versus $32.6 million in the prior yearperiod. The decrease was due to a planned delay in early stage developmentprograms as we focus on supporting our Imagify NDA and MAA submissions,partially offset by increased manufacturing costs for the Imagify program andalso a one time charge for a payment due under an intellectual propertyagreement.

 

The following table summarizes the primary components of ourresearch and development expense for the nine months ended September 30,2008 and 2007:

 
| ** **                             | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                             | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| ** **                             | ** ** | **(In thousands)**                                 | ** ** |
| Imagify                                |       | $                                                       | 13,215     |   | $ | 15,175 |   |
| HDDS and PDDS                          |       | 270                                                     |       | 3,558 |   |
| Other direct costs                     |       | 2,383                                                   |       | 3,041 |   |
| Total direct costs                     |       | $                                                       | 15,868     |   | $ | 21,774 |   |
| Indirect costs:                        |       |                                                    |       |   |   |
| Facility rent costs                    |       | 2,534                                                   |       | 2,613 |   |
| Depreciation                           |       | 7,432                                                   |       | 7,420 |   |
| Other indirect costs                   |       | 1,377                                                   |       | 764 |   |
| Total indirect costs                   |       | 11,343                                                  |       | 10,797 |   |
| Total research and development expense |       | $                                                       | 27,211     |   | $ | 32,571 |   |

 

*LateStage Clinical Development Program**(Imagify).* Our lead product candidate, Imagify, is a cardiovascular drug designedfor the detection of coronary artery disease. Direct expense for research anddevelopment of Imagify was $13.2 million for the nine months ended September 30,2008 versus $15.2 million in 2007. Clinical trial costs relating to Imagify pivotal trials decreased in2008 versus 2007, following the release of RAMP-2 results in May 2007.

 

*EarlyStage Development Programs**(HDDS and PDDS).*  During 2008, we anticipate the costs of earlystage development programs to decrease as we increase our focus on supportingour Imagify NDA and MAA submissions. Because these other programs are in relatively early stages ofdevelopment, we anticipate that costs related to Imagify will continue torepresent our primary research and development expenditures through 2008.

 

*OtherCosts.* Other direct research and development costs primarilyconsist of management and preclinical evaluation of other product candidates.

 

25

----

Table ofContents

 

Each of ourresearch and development programs is subject to risks and uncertainties,including the requirement to seek regulatory approvals, which are outside ofour control.  Moreover, the productcandidates identified in these research and development programs, particularlyour early stage programs, must overcome significant technological, manufacturingand marketing challenges before they can be successfully commercialized. As aresult of these risks and uncertainties, we are unable to predict with anycertainty the period in which material net cash inflows from such projectscould be expected to commence or the completion date of these programs. Failureto commercialize these product candidates on a timely basis could have amaterial adverse affect on our business, financial condition and results ofoperations. We may seek to establish collaborative relationships to help uscommercialize these product candidates, but there can be no assurance that wewill be successful in doing so.

 

*Generaland Administrative Expense.*    Generaland administrative expense for the nine months ended September 30, 2008decreased by $1.1 million, or 11% to $8.6 million versus $9.7 million in theprior period.  The decrease is primarily due to lower salary costs andconsulting costs in marketing.

 

The followingtable summarizes the primary components of our general and administrativeexpense for the nine months ended September 30, 2008 and 2007:

 
| ** **                               | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                               | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| ** **                               | ** ** | **(In thousands)**                                 | ** ** |
| Direct costs                             |       | $                                                       | 7,848      |   | $ | 9,116 |   |
| Indirect costs:                          |       |                                                    |       |   |   |
| Facility costs                           |       | 635                                                     |       | 390 |   |
| Depreciation                             |       | 112                                                     |       | 163 |   |
| Total indirect costs                     |       | 747                                                     |       | 553 |   |
| Total general and administrative expense |       | $                                                       | 8,595      |   | $ | 9,669 |   |

 

*InterestIncome.*    Interest income for the ninemonths ended September 30, 2008 decreased $1.6 million, or 84%, to $0.3million versus $1.9 million in the prior year period.  The decrease wasdue to lower average cash balances during the period.

 

*InterestExpense.*    Interest expense for the ninemonths ended September 30, 2008 decreased $0.5 million, or 31%, to $1.1million versus $1.6 million in the prior year period.   The decreaseis due to lower average loan balances during the period as a result ofrepayments of the capital equipment loans.

 

*Changein Valuation of Derivative.* The derivative is related to the embedded derivative instrument from thedividend make-whole payment feature of the preferred stock offering that closedin February 2005. The derivative liability value is reduced as dividendspayments on the preferred stock are made, as well as for any conversions ofpreferred stock into common stock.  Thederivative liability at September 30, 2008 was valued at $64,000.

 

**Liquidity and Capital Resources**

 

Historically, wehave financed our business through the issuance of equity securities, debtfinancings and equipment leases and, more recently, with funds from ourcollaborations with Nycomed and Cephalon. Our liquidity requirements havearisen primarily from research and development expenditures, equipmentexpenditures and payments on outstanding indebtedness. As of September 30,2008, we had cash and cash equivalents of $4.1 million. As of September 30,2008 we owed approximately $0.1 million for capital leases and $12.4 millionfor notes payable and other long-term obligations. We also had operating leasecommitments totaling $11.1 million for rent of our facilities.

 

On November 3,2008, we closed a transaction with Cephalon which provided $20 million inupfront funding in the form of a $15 million senior secured convertible noteand receipt of a $5 million upfront fee for an exclusive worldwide license toAI-525, a preclinical-stage injectable formulation of celecoxib using theCompany’s proprietary Hydrophobic Drug Delivery System (HDDSTM) technology.

 

We expect that ourexisting resources, together with funds from the Cephalon transaction will fundoperations into but not beyond the second quarter of 2009.  We will require significant additional fundsin order to continue to fund our operations through and beyond the secondquarter of 2009. We may raise these funds through public or private sales ofequity, or from borrowings, or from strategic partners. Our future capitalrequirements will depend on many factors, including the scope and progress madein our research and development activities and the size and timing of creatingexpanded manufacturing capabilities. We do not expect to generate significantrevenues from Imagify, other than possible license or milestone payments,unless or until we or current or potential 

 

26

----

Table ofContents

 

partners submit anapplication for and receive marketing approval from the applicable regulatoryauthorities. The depletion of our resources may make future funding moredifficult or expensive to attain. When additional funds are required or, inadvance of such requirements, we may raise such funds from time to time throughpublic or private sales of equity or from borrowings or from strategic partnersor we may delay funding of certain development activities which could delay theapproval and/or commercialization of Imagify, which would have a negativeimpact on our growth plans. We are evaluating our funding alternatives.Additional equity financing will be dilutive to our stockholders; debtfinancing, if available, may involve significant cash payment obligations andcovenants that restrict our ability to operate as a business; and strategicpartnerships may result in royalties or other terms which reduce our economicpotential from products under development, including Imagify.  Since our present capital resources are notsufficient to fund our planned operations through and beyond the second quarterof 2009, substantial doubt about our ability to continue as a going concernexists without successfully raising funds as described above.  If we are unable to execute our operationsaccording to our plans or to obtain additional financing, we may be forced tocease operations.

 

During the ninemonths ended September 30, 2008, operating activities used approximately$17.1 million of cash. Net cash used by operating activities during this periodresulted primarily from a net loss of $34.8 million, partially offset byan increase in deferred revenue of $10.8 million as a result of the licenseagreement with Cephalon, Inc. and an amendment to the Nycomed Agreementand non-cash charges for depreciation, amortization and stock basedcompensation of $9.0 million.

 

During the ninemonths ended September 30, 2008, investing activities used approximately$0.1 million in cash. This use of cash was primarily used for purchases ofequipment incurred in connection with our commercial manufacturing facility forImagify.

 

During the ninemonths ended September 30, 2008, financing activities used$4.8 million in cash, primarily due to payments on long term obligations.

 

We presentlyestimate that the total quarterly cash outflows for the remainder of 2008 to beapproximately $8 to $9 million.

 

On July 28, 2008, we eliminated 24 positions or approximatelytwenty-four percent (24%) of its workforce and began notifying the affectedemployees.  In addition, pursuantto the Senior Management Compensation Plan approved by the CompensationCommittee of the our Board of Directors on July 25, 2008, all seniormanagers at the Vice President level and above have taken salary reductions of 10% or more, to further decreaseoperating costs while the Company awaits FDA review of its NDA forImagify.  The salary reductions wereeffective on August 1, 2008.  In connection with this reduction, incurred apre-tax costs in the third quarter of 2008 of approximately $0.3 million, whichis related to severance and benefit costs. The total annualized pre-tax costsavings that are expected to result from this reduction and the salaryreductions described above are estimated to be approximately $2.1 million. Inaddition, the termination of certain of our outside consultants and contractorswill result in estimated annual savings of approximately $2.0 million.  Although we believe that our estimates areappropriate and reasonable based on available information, actual results coulddiffer from these estimates.

 

Our currentvacation policy allows employees to carry over unused vacation time as of December 31of each year, up to a maximum of two weeks. However, several employees who joined Acusphere prior to the institutionof this vacation policy had accumulated more than two weeks vacation at December 31,2007.  These employees had been allowedto carry this excess vacation accrual forward each year.  In April 2008 approximately $0.7 millionof this accumulated vacation liability to employees was paid in a lump sumpayment.

 

On May 15,2008, we entered into a second amendment (the “Second GE Amendment”) to the GEpatent license agreement.  Under the First amendment with GE (the “FirstGE Amendment”), we were due to make a series of six (6) consecutive quarterlyinstallments of approximately $0.9 million due on the first day of the thirdmonth of each calendar quarter, commencing on June 1, 2008.  TheSecond GE Amendment provides that, in lieu of these payments, we shall make aseries of payments due as follows: $5.5 million due as of June 1, 2007,payable in two installments commencing on June 1, 2008, the firstinstallment of approximately $0.9 million is due on June 1, 2008 and waspaid in May 2008 and the remaining installment is due and payable on October 1,2009 in an amount consisting of (i) the amount of approximately $4.6million in principal plus (ii) interest accruing on such principal amountfrom July 1, 2008 at the rate of 6% per annum until paid in full.  Ifreceipt of regulatory approval by the U.S. Food and Drug Administration tomarket Imagify in the United States, or the approval of a MarketingAuthorization Application to market Imagify in Europe, is received priorto the October 1, 2009 due date, any then remaining balance of theapproximately $4.6 million (plus interest accrued to such date) payable asdescribed above shall be immediately due and payable in full. The currentcarrying value of the later payment has been included in the current portion oflong-term obligations at September 30, 2008.

 

27

----

Table ofContents

 

On May 15,2008, we entered into a second amendment (the “Second BSP Amendment”) to theSchering patent transfer agreement.  Under the First BSP Amendment, wewere due to make a payment of $1.0 million to Schering on or before fifteendays after May 11, 2008 and a payment of another $1.0 million to Scheringon or before fifteen days after May 11, 2009.  The Second BSPAmendment provides that, in lieu of these payments, we shall make a series ofpayments due as follows: $200,000 on or before fifteen days following executionof the Second BSP Amendment and $1.8 million on or before fifteen days after May 11,2009.  The $200,000 payment was paid in May 2008 and the currentcarrying value of the remaining $1.8 million has been included in the currentportion of long-term obligations at September 30, 2008.

 

In March 2008we entered into a license agreement with Cephalon, Inc. (“Cephalon”)providing Cephalon with an exclusive, worldwide license to the Company’sHydrophobic Drug Delivery System (HDDS) for oncology applications, along withthe rights to AI-850, our formulation of paclitaxel, in exchange for a cash paymentof $10.0 million, paid upon the execution of the agreement.  The term ofthe agreement extends until expiration of the last of the patents licensedunder the agreement.  We have recordedthis payment in deferred revenue at September 30, 2008, and will recognizeit as income ratably over the remaining estimated useful life of the patents,or approximately 13 years.

 

Effective June 1,2006, we entered into an agreement to license on a non-exclusive basis variousultrasound-related intellectual property from Bracco International BV, orBracco. In consideration for the non-exclusive license of these patents, weagreed to pay Bracco up to a total ofEuros 3.0 million, of which Euros 0.5 million (approximately $0.6million) was paid in June 2006. On July 29, 2008, we entered into anamendment (the “Amendment”) to the Bracco patent license agreement.  Under the Bracco patent license agreement, wewere obligated to make a payment of Euros 500,000 (approximately $0.8 million)to Bracco within five business days after the acceptance by the FDA of a newdrug application filing package for Imagify. The FDA accepted our application on June  30, 2008, makingsuch payment to Bracco due on July 8, 2008.  The Amendment reduces the amount of thepayment due on July 8, 2008 to Euros 100,000 (approximately $0.2 million),and provides that an additional payment of Euros 400,000 (approximately$0.6 million) will be due on the first anniversary of such acceptance by theFDA, or June 30, 2009.  TheAmendment further provides that we grant Bracco a perpetual non-exclusive androyalty-free right and license within the field of ultrasound diagnosticimaging to use and exploit any intellectual property that we have developed ormay develop after June 1, 2006 which relates to, or to the use orperformance of, the patents licensed by Bracco under the Agreement.  We have paid this Euro 100,000 (approximately$0.2 million) in August 2008 and the additional payment ofEuros 400,000 (approximately $0.6 million) that is due on the first anniversaryof such acceptance by the FDA, or June 30, 2009 has been included incurrent liabilities as of September 30, 2008.  An additional Euros 2.0 million is payableupon our achievement of certain defined regulatory milestones.  We also agreed to pay a royalty on futureImagify revenue, up to a maximum royalty amount of Euros 10.0 million, less aportion of the above-referenced milestone payments. Whereas the otherobligations are contingent upon the outcome of future events, they have notbeen recorded at this time.

 

On each of May 18,2007, March 28, 2007 and January 5, 2007, we entered into promissorynotes under an equipment financing line with General Electric CapitalCorporation (“GE Capital”) each of which totaling in aggregate originalprincipal amount approximately $0.3 million for equipment already purchased byus. The promissory notes include annual interest rates of 10.55%, 10.41% and10.60%, respectively, and are payable over 42 consecutive months. Thepromissory notes are secured by the equipment financed pursuant to the terms ofour Master Security Agreement with GE Capital. The notes are subject toacceleration upon certain events of default, including but not limited to: i)the failure to make timely payments of principal and interest, ii) a default onother material obligations, or iii) a material adverse change in the financialcondition of the borrower.

 

In June 2005,we entered into an equipment financing line with Oxford Finance Corporation, (“Oxford”).  In 2005 and 2006, we borrowed an aggregate of$7.0 million against this line. As of September 30, 2008, net ofrepayments, we had $2.0 million outstanding under this line. Such borrowingsare collateralized by corresponding equipment and other capital purchases withrepayment due in monthly installments over 36 to 48 months, depending onthe nature of the equipment financed, with the last such repayment scheduledfor March 2010. Interest rates on these borrowings were fixed at the timeof each borrowing and range from 10.3% to 10.9%.  The loans under this line are subject toacceleration upon certain events of default, including but not limited to thefailure to make timely payments of principal and interest, a default on othermaterial obligations, or a material adverse change in the financial conditionof the borrower.

 

In March 2005we borrowed $2.0 million under a loan agreement with MassDevelopment to helpfinance certain tenant improvements to its commercial manufacturing facility inTewksbury, Massachusetts. The loan is secured by certain improvements made atthe facility, interest accrues at 5.0% per annum with retroactive adjustmentsto 9.0% in the event the we achieve positive operating cash flow, as defined inthe agreement, prior to repayment of the loan. Accrued principal and interestare being repaid over a 10 year term. The loan is subject to acceleration uponcertain customary events of default, including failure to timely pay principaland interest. We 

 

28

----

Table ofContents

 

began makingpayments on this loan in May 2007 and as of September 30, 2008, haveapproximately $2.1 million outstanding under the loan, including principal andinterest.

 

In February 2005, we issued 900,000 shares of 6.5% convertible exchangeable preferredstock, our Preferred Stock, at $50.00 per share resulting in net proceeds ofapproximately $41.9 million after deducting underwriting discounts, commissionsand offering expenses. Each share of Preferred Stock has a liquidationpreference of $50.00 per share. Dividends on the Preferred Stock are cumulativefrom the date of original issue at the annual rate of $3.25 per share, payablequarterly on the first day of March, June, September, and December. Anydividends must be declared by our board of directors and must come from fundsthat are legally available for dividend payments.  During the nine monthsended September 30, 2008 and 2007, we paid $0 and $1.7 million,respectively, in dividends on our Preferred Stock. As of September 30,2008, 480,000 shares of Preferred Stock were outstanding, accrued and unpaiddividends totaled approximately $0.8 million.

 

In February 2008 and May 2008, our Board ofDirectors elected not to declare a quarterly cash dividend that was otherwisepayable on March 1, 2008 and June 1, 2008, respectively. On August 24,2008, our Board of Directors again elected not to declare a quarterly cashdividend in the amount of $0.8125 per share on the preferred stock that wasotherwise payable on September 1, 2008. This is the third quarterlydividend that has not been declared and paid on the preferred stock.  Thisdividend payable on September 1, 2008, which would have totaled $0.4million in the aggregate.  The total of$0.8 million has been included in current liabilities as of September 30,2008.  If we have not paid dividends onthe preferred stock in an aggregate amount equal to at least six quarterlydividends whether or not consecutive, we must increase the size of our Board ofDirectors by two additional directors. After this time, and for so long asthese dividends remain due and unpaid, holders of the Preferred Stock, votingseparately as a class with holders of Preferred Stock ranking on the same basisas to dividends having like voting rights, will be entitled to elect twoadditional directors at any meeting of stockholders at which directors are tobe elected.

 

We may elect toautomatically convert some or all of the Preferred Stock into shares of ourcommon stock if the closing price of our common stock has exceeded $10.30 pershare (150% of the conversion price) for at least 20 trading days during any30-day trading period, ending within five trading days prior to notice ofautomatic conversion. Prior to March 1, 2009, if we elect to automaticallyconvert, or if any holder elects to voluntarily convert, the Preferred Stock,we will also make an additional payment, the Make-Whole payment, equal to theaggregate amount of dividends that would have been payable on the PreferredStock so converted from the original date of issuance through and including March 1,2009, less any dividends already paid on the Preferred Stock. This additionalpayment is payable by us, at our option, in cash, in additional shares of itscommon stock, or in a combination of cash and shares of common stock.  Wehave reserved a maximum of approximately 0.3 million shares of common stock forissuance under this Make-Whole provision.

 

Through September 30,2008, 420,000 shares of Preferred Stock have been voluntarily converted into3,061,223 shares of our common stock. In connection with such conversions, weissued an additional 490,504 shares of our common stock in satisfaction of therequired Make-Whole payment.

 

We may elect toredeem the Preferred Stock at declining redemption prices on or after March 6,2009.  The Preferred Stock is exchangeable, in whole but not in part, atour option on any dividend payment date beginning on the exchange date (March 1,2006) for our 6.5% convertible subordinated debentures, or the Debentures, atthe rate of $50 principal amount of Debentures for each share of PreferredStock. The Debentures, if issued, will mature 25 years after the exchange dateand have terms substantially similar to those of the Preferred Stock.

 

In April 2004,we entered into an equipment financing line with General Electric CapitalCorporation.  In 2004 and 2005 weborrowed an aggregate of $10.5 million under the equipment financing line.  As of September 30, 2008, net ofrepayments, we had $2.5 million outstanding. Borrowings are collateralized by the equipment financed with repaymentdue in monthly installments over 36 to 48 months, with the last such repaymentscheduled for December 2010. Interest rates on these borrowings were fixed at the time of eachborrowing and range from 8.7% to 10.7%. The loans under this line are subjectto acceleration upon certain events of default, including but not limited to:i) the failure to make timely payments of principal and interest, ii) a defaulton other material obligations, or iii) a material adverse change in thefinancial condition of the borrower.

 

In July 2004,we entered into a collaboration, license and supply agreement with Nycomed inwhich we granted Nycomed rights to develop and market Imagify in Europe. Underthe original terms of this agreement, Nycomed paid us license fees and researchand development payments totaling $12.0 million. The original agreement alsoprovides for Nycomed to pay to us up to $58.0 million in milestonepayments upon achievement of certain milestones. Under the agreement, Nycomedhas agreed to pay us to manufacture Imagify for them and to pay us royalties onNycomed’s sales of Imagify. In October 2005 and February 2006, ouragreement with 

 

29

----

Table ofContents

 

Nycomed wasamended such that Nycomed paid us an additional $2.0 million for trademarkactivities and activities associated with the qualification of ourmanufacturing facility. Subsequently in September 2008, this arrangementwith Nycomed was amended.  This amendmentremoved a contingency associated with the $2.0 million of payments.  These amendments were considered advances againstfuture milestone payments, and have been deducted from the $58 million inremaining milestone payments.  Therefore,we have $56 million remaining in milestone payments. No additional funds areexpected from Nycomed under the agreement for the next twelve months.  On June 26, 2008, we executed a thirdamendment to our agreement with Nycomed.  Pursuant to the amendment,Nycomed shall reimburse us for expenses arising from and after June 1,2008 and related to our qualification of our commercial manufacturing facilityin Tewksbury, Massachusetts.  Such amounts shall not, in the aggregate,exceed $750,000 and are payable by Nycomed upon receipt of monthlyinvoices.  The amendment further provides that $750,000 shall be creditedagainst Nycomed’s initial purchases of Imagify so that Nycomed shall only payfor Imagify delivered after such $750,000 has been fully credited.

 

**ShelfRegistration Statement**

 

We have on file with the U.S. Securities and ExchangeCommission, or SEC, a “universal shelf” registration statement on Form S-3(Registration No. 333-134263), which provides for the offer, from timeto time, of common stock, preferred stock, debt securities and warrants up toan aggregate remaining availability, as of September 30, 2008, ofapproximately $33.5 million, subject to our satisfaction of the criteria foruse of Form S-3. The SEC declared the shelf registrationstatement effective on August 18, 2006.  SEC rules currentlylimit our ability to utilize a shelf registration statement to no more than one-thirdof our unaffiliated public float over any twelve month period. Subject to theselimitations, market conditions and our capital needs, and to the extent and solong as we are then eligible to use the registration statements under SECrules, we may again seek to use any remaining availability under the shelfregistration statements by making an offering of securities covered for saleunder the registration statements. In addition, we may amend our shelfregistration statements or file a new shelf registration statement toincrease our potential access to capital. If we elect to raise additionalcapital using a shelf registration statement, we may use the net proceeds fromthe sale of these securities for general corporate purposes, which may include fundingclinical trials, research and development, regulatory activities, acquisitions,including acquisitions of companies, products, intellectual property or othertechnology, repayment or refinancing of existing indebtedness, investments,capital expenditures, repurchase of our capital stock and for any otherpurposes that we may specify in any prospectus supplement.

 

**Off-BalanceSheet Financing Arrangements**

 

We currently donot have any special purpose entities or off-balance sheet financingarrangements other than operating leases.

 

**ContractualObligations**

 

The followingtable summarizes our contractual obligations as of September 30, 2008 andthe effect such obligations are expected to have on our liquidity and cash flowin future periods:

 
| ** **                       | ** ** | **Payments Due by Period (in 000’s)** | ** ** |
|----------------------------------|------------|---------------------------------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                                                           | ** ** | **2008** | ** ** | **2009 - 2010** | ** ** | **2011 - 2012** | ** ** | **2013 and  Beyond** | ** ** |
| Long-Term Debt                   |       | $                                                                   | 6,933      |   | 1,370 |   | 4,130 |   | 670 |   | 763 |   |
| Capital Lease Obligations        |       | 50                                                                  |       | 8 |   | 42 |   | — |   | — |   |
| Operating Lease Obligations      |       | 11,060                                                              |       | 770 |   | 6,092 |   | 4,198 |   | — |   |
| Purchase Obligations             |       | 112                                                                 |       | 112 |   | — |   | — |   | — |   |
| Other Long-Term Obligations      |       | 7,310                                                               |       | — |   | 7,310 |   | — |   | — |   |
| **Total**                        |       | $                                                                   | 25,465     |   | 2,260 |   | 17,574 |   | 4,868 |   | 763 |   |

 

Long-Term Debt of $6.9 million includes $2.6 million in principal andinterest payable to General Electric Capital Corporation (“GE”) and $2.2 million in principal andinterest payable to Oxford Finance Corporation (“Oxford”) under equipment loanswith payments due in monthly installments over 36 to 48 months,collateralized by the corresponding equipment.  The loans under the GEline are subject to acceleration upon certain events of default, including butnot limited to: i) the failure to make timely payments of principal andinterest, ii) a default on other material obligations, or iii) a materialadverse change in the financial condition of the borrower.  Theloans under the Oxford line are subject to acceleration upon certain events ofdefault, including but not limited to the failure to make timely payments ofprincipal or a default on other material obligations.

 

30

----

Table ofContents

 

Also includedunder Long-Term Debt is $2.1 million in principal and interest payments dueunder the MassDevelopment loan, under which we borrowed $2.0 million to financeimprovements to our commercial manufacturing facility in Tewksbury,Massachusetts. Interest accrues under the loan at 5.0% per annum withretroactive adjustments to 9.0% in the event we achieve positive operating cashflow as defined in the agreement without prior repayment of the loan. Nopayments were due under the loan for the first 24 months and we began loanrepayments in May 2007. The loan has a 10 year repayment term and issubject to acceleration upon certain events of default, including failure totimely pay principal and interest.

 

Capital Lease Obligations asclassified pursuant to FASB Statement of Financial Accounting Standards No. 13,*Accounting for Leases*relate to leases for businessequipment.  We leased capital equipmentthrough Banc of America Leasing Corporation. The remaining monthly paymentsrange from $460 to $1,019 with maturities through June 2010.

 

Our operatinglease obligations of $11.1 million relate primarily to our headquarters andmanufacturing facility leases under which we pay monthly rent. Our Watertown,Massachusetts headquarters lease has an original term of 10 years, which beganin December 2001, and which was extended by six months during 2005. Thelease for our commercial manufacturing space in Tewksbury, Massachusetts has aninitial five year, nine month term, which began in July 2004, with optionsto extend the lease for up to two additional five-year terms at predeterminedrental rates.

 

Purchase Obligations include one purchase order to asupplier for material.

 

Other Long-Term Liabilities includes approximately$4.9 million payable to GE Healthcare pursuant to the amended intellectualproperty license agreement which is due and payable on October 1, 2009 inan amount consisting of (i) the amount of approximately $4.6 million inprincipal plus (ii) interest accruing on such principal amount from July 1,2008 at the rate of 6% per annum until paid in full.  Other Long-Term Liabilities also includes$1.8 million payable which is due and payable in May 2009 to pursuant tointellectual property acquisition agreement. Other Long-Term liabilities Euro 400,000 (approximately $0.6 million)due on June 30, 2009 to Bracco pursuant to a patent license agreement.

 

**CriticalAccounting Policies and Estimates**

 

Our discussion andanalysis of our financial condition and results of operations are based on ourconsolidated financial statements, which have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses. Onan on-going basis, we evaluate our estimates and judgments, including thoserelated to revenues, accrued expenses, fair valuation of stock related tostock-based compensation and income taxes. We base our estimates on historicalexperience and on various other assumptions that we believe to be reasonableunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

 

We believe thefollowing critical accounting policies affect our more significant judgmentsand estimates used in the preparation of our consolidated financial statements.

 

*Revenue.  * We recognize revenue from licensearrangements in accordance with Staff Accounting Bulletin No. 104, *Revenue Recognition* (“SAB 104”) and FASB Emerging Issue TaskForce Issue No. 00-21, *Accounting for RevenueArrangements with Multiple Deliverables* (“EITF 00-21”). We recognizerevenue from license payments not tied to achieving a specific performancemilestone ratably over the period over which we are obligated to performservices. The period over which we are obligated to perform services isestimated based on available facts and circumstances. We recognize revenue fromperformance payments, when such performance is substantially in our control andwhen we believe that completion of such performance is reasonably probable,ratably over the period over which we estimate that we will perform suchperformance obligations. Substantive at-risk milestone payments, which are basedon achieving a specific performance milestone when performance of suchmilestone is contingent on performance by others or for which achievement cannot be reasonably estimated or assured, are recognized as revenue when themilestone is achieved and the related payment is due, provided that there is nosubstantial future service obligation associated with the milestone. We do notrecognize revenue in connection with license arrangements until payments arecollected or due and reasonably assured of being collected. In addition, we donot recognize revenue in circumstances where the arrangement includes a refundprovision until the refund condition is no longer applicable unless, in ourjudgment, the refund circumstances are within our operating control and unlikelyto occur. Payments received in advance of being recognized as revenue aredeferred.

 

31

----

Table ofContents

 

In connection withfeasibility studies, contract amounts which are not due until thecustomer accepts or verifies the research results are not recognized as revenueuntil customeracceptance, assuming collectability is reasonable assured.

 

We are recognizingcollaboration revenue of $14.0 million associated with the initial license andperformance-based payments under the Nycomed agreement based on an estimatedrecognition period of 66 months over which we are obligated to perform servicessupporting the agreement. This estimate was revised to 66 months in the thirdquarter of 2008.  There was no change inthe estimated development period during 2007. Estimation of this development period involves many assumptions,including estimates relating to completion of activities for which we arereliant on Nycomed and independent regulatory authorities to achieve.  Our estimated development recognition periodmay change again if facts and circumstances change. Were the estimateddevelopment period to be extended, we may be required to record a reduction incumulative revenue recognized in our statement of operations in the period inwhich the change in development period is determined.

 

Our agreement withNycomed has been modified such that Nycomed has paid us $0.2 million for activitiesassociated with creating a brand name for Imagify and related trademarkactivities and paid us $1.8 million to support the validation of the ourcommercial manufacturing facility for Imagify. These amounts were originallyscheduled to be paid to us upon Nycomed’s filing for regulatory approval ofImagify in Europe. In September 2008, the arrangement with Nycomed wasamended.  This amendment removed acontingency associated with the $2.0 million of payments.  As a result the $2.0 million has been includedwith $12 million and will be recognized over the 66 month development periodutilizing the cumulative catch-up methodology. Payments received for current and potential HDDS and PDDS feasibilitystudies, which are offset by costs incurred for such studies, are recognized asrevenue over the estimated performance period of each such study. A change inthese estimates could result in a significant change to the amount of revenuerecognized in future periods. In addition, if the Nycomed collaboration agreementis terminated for reasons other than certain non-performance by us, we wouldrecognize the remainder of the payments we have received or otherwise expect tocollect over the amortization period at the time of termination. We will notrecognize revenue associated with the potential additional $56 million inmilestone-based payments that may be earned under the Nycomed agreement untilthe underlying regulatory and sales milestones are achieved.

 

We entered into alicense agreement with Cephalon, Inc., providing Cephalon with a licenseto our Hydrophobic Drug Delivery System (HDDS) for oncology applications, alongwith the rights to AI-850, our formulation of paclitaxel, in exchange for acash payment of $10.0 million, paid upon the execution of the agreement. The term of the agreement extends until expiration of the last of the patentslicensed under the agreement.  During theterm of the license we are obligated to support Cephalon activities inconnection with AI-850.  This supportincludes allowing access to our personnel for discussions relating toregulatory, scientific and medical technology and allow access to any recordsthat may be required in connection with any regulatory filings orsubmissions.  The Chairman, founder andCEO of Cephalon is also the current Presiding Director of the Board ofDirectors of the Company.  MartynGreenacre is also a member of the Board of Directors of both the Company andCephalon.  We recorded this payment indeferred revenue at September 30, 2008, and are recognizing it as incomeratably over the remaining estimated useful life of the patents, orapproximately 13 years.

 

*Propertyand Equipment.*  Property and equipment are recorded at cost and depreciated over theirestimated useful lives of three to five years using the straight-line method.The majority of our equipment is related to our ongoing research anddevelopment activities, including equipment which, subject to regulatoryapprovals, we intend to use for commercial manufacture of Imagify. We considerthat this equipment is placed in service when operation of the equipment isstarted-up and begin depreciating the equipment at this time. The equipment inour commercial manufacturing facility is currently undergoing research anddevelopment related activities that result in wear and tear on the equipmentincluding ongoing calibration and testing.

 

Leaseholdimprovements and equipment under capital leases are recorded at cost. Wedepreciate leasehold improvements and equipment under capital leases over thelesser of their useful lives or the remainder of their respective lease terms.We began depreciation of leasehold improvements at our Tewksbury facility in October 2005upon receipt of an occupancy permit and taking occupancy of the facility. Ourleasehold improvements costs on this facility approximate $30.7 million and arebeing depreciated ratably over the remaining term of our present lease, theinitial term of which is scheduled to expire in April 2010. We believethat the use of the initial term of the lease for the depreciation period,rather than assuming that the lease term is renewed, is appropriate given theinherent uncertainties with a product such as Imagify, which has completed itsphase 3 clinical trials but still requires regulatory approvals before it canbe marketed.  The Risk Factors included under Section 1A of thisdocument discuss the uncertainties associated with Imagify.

 

*AccruedExpenses.*  As part of the process of preparing consolidated financial statements we arerequired to estimate accrued expenses. This process involves identifyingservices which have been performed on our behalf and estimating the level ofservice performed and the associated cost incurred for such service as of eachbalance sheet date in our consolidated financial statements. 

 

32

----

Table ofContents

 

Examples ofestimated expenses for which we accrue include professional service fees, suchas lawyers and accountants, and contract service fees such as amounts paid toclinical monitors, data management organizations and investigators inconjunction with clinical trials, and fees paid to consultants used in thequalification of our commercial manufacturing facility for Imagify. Inconnection with such service fees, our estimates are most affected by ourunderstanding of the status and timing of services provided relative to theactual levels of services incurred by such service providers. The majority ofour service providers invoice us monthly in arrears for services performed. Inthe event that we do not identify certain costs which have begun to be incurredor we under- or over-estimate the level of services performed or the costs ofsuch services, our reported expenses for such period would be too low or toohigh. The date on which certain services commence, the level of servicesperformed on or before a given date and the estimate of cost of such servicesat a cutoff date are often judgmental. We make these judgments based upon thefacts and circumstances known to us in accordance with accounting principlesgenerally accepted in the United States of America.

 

*Stock-BasedCompensation and Other Equity Instruments.  * We account for stock-based compensationin accordance with the fair value recognition provisions of SFAS 123R, *Share-Based Payment*. Under SFAS 123R, stock-basedcompensation cost is measured at the grant date based on the fair value of theaward and is recognized as expense over the appropriate vesting period.Determining the fair value of stock-based awards at the grant date requiresjudgment, including estimating the expected term of stock options, the expectedvolatility of our stock and expected dividends. In addition, judgment is requiredin estimating the amount of stock-based awards that are expected to beforfeited. If actual results differ significantly from these estimates ordifferent key assumptions were used, it could have a material effect on ourConsolidated Financial Statements. See Note 3 of the Notes to theConsolidated Financial Statements for additional information regardingstock-based compensation expense.

 

Accounting forequity instruments granted or sold by us under APB No. 14, APB No. 25,SFAS 123 and EITF No. 96-18, such as the warrants issued inconjunction with certain sales of common stock, requires fair value estimatesof the equity instrument granted or sold. If our estimates of the fair value ofthese equity instruments are too high or too low, it would have the effect ofoverstating or understating expenses. When equity instruments are granted orsold in exchange for the receipt of goods or services and the value of thosegoods or services can be readily estimated, we use the value of such goods orservices to determine the fair value of the equity instruments. When equityinstruments are granted or sold in exchange for the receipt of goods orservices and the value of those goods or services can not be readily estimated,as is true in connection with most stock options and warrants granted toemployees or non-employees, we estimated the fair value of the equityinstruments based upon consideration of factors which we deemed to be relevantat the time using cost, market and/or income approaches to such valuations.

 

The fair values ofall stock option grants issued were determined using a Black-Scholes model inwhich we are required to make assumptions for the risk-free interest rate, theexpected volatility of the underlying stock, forfeiture rates and expected lifeof option grants.  The risk-free ratesare the weighted average of the yield rates on 5-year U.S. Treasury noteson the dates of the stock option grants. We used the historical volatility ofour market-traded stock for the expected volatility assumption. Forfeiturerates are calculated based on actual historical forfeitures.  The expected life of employee stock optionsrepresents the weighted-average period the stock options are estimated toremain outstanding. The expected life of employee stock options is, in part, afunction of the options’ remaining contractual life and the extent to which theoption is in-the-money (i.e., the average stock price during the period isabove the strike price of the stock option). We estimate that, based on thesevariables, options are likely on average to be exercised in approximately 5years from the date of grant.

 

*DerivativeLiabilities.  * The terms of our February 2005 convertible preferred stockoffering and our March 2005 MassDevelopment loan agreement contain featuresconsidered to be embedded derivatives which are recorded at estimated fairvalue in accordance with SFAS 133. The estimation of this fair value includesvarious assumptions and estimates, including assumptions and estimates of riskfree interest rates, stock price volatility and the timing of future preferredstock conversions. Changes in these estimates and assumptions can increase ordecrease the value of this derivative liability.  The unrealized gain orloss of the derivative financial instrument is included in our statement ofoperations. The convertible preferred stock terms include a dividend make-wholepayment provision, which has been initially recorded at its estimated fairvalue. This derivative liability is reduced upon conversion of the preferredstock as well as dividends declared by our board of directors, if any. TheMassDevelopment loan agreement includes a provision for a retroactive interestrate increase in the event that we achieve certain defined positive operatingcash flows. The initial fair value of the MassDevelopment loan derivative isbeing amortized over a term beginning with the loan agreement effective dateand ending with the estimated payment date of the retroactive interest. Thefair value of both derivative liabilities are re-measured at each reportingperiod.

 

*IncomeTaxes.  *Deferred tax liabilities and assets are provided for differences between thebook and tax bases of existing assets and liabilities and tax losscarryforwards and credits, using tax rates expected to be in effect in theyears in which differences are expected to reverse. Valuation allowances areprovided to the extent realization of tax assets is not considered likely.

 

33

----

Table ofContents

 

On January 1,2007 we adopted FASB Interpretation No. 48 (“FIN 48”), *Accounting for Uncertainty in Income Taxes — an Interpretation ofFASB Statement No. 109*, which clarifies the accounting for uncertaintyin income tax positions. Under FIN 48, the impact of an uncertain income taxposition on the income tax return must be recognized at the largest amount thatis more-likely-than-not to be sustained upon audit by the relevant taxingauthority. An uncertain income tax position will not be recognized if it hasless than a 50% likelihood of being sustained. Additionally, FIN 48 providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure and transition.

 

There were no unrecognized tax benefits as of the date ofadoption January 1, 2007. As a result of the implementation of FIN 48, wedid not recognize an increase in the liability for unrecognized tax benefits.There are no unrecognized tax benefits included in the balance sheet thatwould, if recognized, affect the effective tax rate. The Company’s practice isto recognize interest and/or penalties related to income tax matters in incometax expense. We had no accrual for interest or penalties on our balance sheetsat December 31, 2007 and at September 30, 2008, and has notrecognized interest and/or penalties in the statement of operations for theperiod ended December 31, 2008.

 

**RecentlyIssued Accounting Pronouncements**

 

In September 2006, the FASB issued SFAS (FAS) No. 157, *Fair Value Measurements*(“SFAS No. 157”), which is effectivefor financial statements issued for fiscal years beginning after November 15,2007, and interim periods within those fiscal years. The purpose of FAS No. 157is to clarify and set forth consistent rules for defining fair value,establishing a framework for measuring fair value in generally acceptedaccounting principles and expanding disclosures about fair value measurements. SFAS157 applies under other accounting pronouncements that require or permit fairvalue measurements where those accounting pronouncements have determined thatfair value is the relevant measurement attribute. FAS No. 157 does not requireany new fair value measurements, but for some entities the application of FASNo. 157 could change current practice. Except as described below, we have adopted SFAS No. 157 on January 1,2008. The adoption of SFAS No. 157 did not have a material impact on ourfinancial statements or disclosures.

 

In February 2008, FASB issued FASB FSP FAS 157-2, *Effective Date of FASB Statement No. 157* (FSP 157-2).FSP 157-2 will provide a one-year deferral of the effective date of SFAS No. 157for non-financial assets and non-financial liabilities, except those that arerecognized or disclosed in financial statements at fair value at leastannually. For non-financial assets and non-financial liabilities subject to thedeferral, SFAS No. 157 will be effective in fiscal years beginning after November 15,2008 and in interim periods within those fiscal years. We are currentlyevaluating the impact that applying FAS No. 157 to nonfinancial assets andliabilities will have on our consolidatedfinancial statements.

 

In February 2007,the FASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities,* which is effective as of the beginning of an entity’sfirst fiscal year beginning after November 15, 2007.  This statement allows the measurement at fairvalue of financial instruments and certain other items that are currently notrequired to be measured at fair value. The objective of SFAS No. 159 is toimprove financial reporting by providing entities with the opportunity tomitigate volatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accountingprovisions. The fair value option established by this Statement permits themeasurement of eligible items at fair value at specified election dates, withunrealized gains and losses on the items for which the fair value option hasbeen elected reported in earnings at each subsequent reporting date.  SFAS No. 159 was effective for us in thefirst quarter of 2008. The adoption of SFAS No. 159 did not have an impacton our financial statements or condition as we did not elect to use fair valuemeasurements on any assets or liabilities under this statement and have notsubsequently elected to carry any assets or liabilities at fair value.

 

In June 2007,the Emerging Issues Task Force issued EITF 07-3, *Accountingfor Nonrefundable Advance Payments for Goods or Services Received for Use inFuture Research and Development Activities*, which is effective as of the beginning of an entity’s firstfiscal year beginning after December 15, 2007.  This abstract discusses the treatment of thenonrefundable portion of advance payments made pursuant to an executorycontractual arrangement for future research and development activities.  Nonrefundable advance payments for goods orservices that will be used or rendered for future research and developmentactivities should be deferred and capitalized. Such amounts should berecognized as an expense as the related goods are delivered or the relatedservices are performed. If an entity does not expect the goods to be deliveredor services to be rendered, the capitalized advance payment should be chargedto expense.  We adopted this statement asof January 1, 2008 and concluded it has no effect on our consolidatedfinancial statements.

 

34

----

Table ofContents

 

In March 2008, the FASB issued SFAS No. 161, an amendment of SFAS No. 133,*Accounting for Derivative Instruments and HedgingActivities**,*which is effective as of the beginning of an entity’s first fiscal yearbeginning after November 15, 2008.  ThisStatement changes the disclosure requirements for derivative instruments andhedging activities, requiring enhanced disclosures about (a) how and whyan entity uses derivative instruments, (b) how derivative instruments andrelated hedged items are accounted for under Statement 133 and its relatedinterpretations, and (c) how derivative instruments and related hedgeditems affect an entity’s financial position, financial performance, and cashflows.  We are assessing the impact, if any, of thispronouncement on our consolidated financial statements.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

We have not usedderivative financial instruments for speculative or trading purposes. However,we are exposed to market risk related to changes in interest rates. Our currentpolicy is to maintain an investment portfolio consisting mainly of U.S. moneymarket and government-grade securities, directly or through managed funds, withoriginal maturity dates of 90 days or less when purchased. Our cash isdeposited in and invested through highly rated financial institutions in NorthAmerica. Our cash equivalents are subject to interest rate risk and will fallin value if market interest rates increase. If market interest rates were toincrease immediately and uniformly by 10% from levels at September 30,2008, we estimate that the fair value of our investment portfolio would declineby an immaterial amount.   Since ourinvestment portfolio consists of short-term, highly liquid investments,including money market accounts, with original maturity dates of 90 daysor less when purchased, we do not expect our operating results or cash flows tobe affected to any significant degree by the effect of a change in marketinterest rates on our investments. Our equipment loans and capital leases arenot subject to interest rate fluctuations because the interest rates are fixedat the time of borrowing.

 

**Effects of Inflation**

 

Our assets areprimarily monetary, consisting of cash, cash equivalents and short-terminvestments. Because of their liquidity, these assets are not directly affectedby inflation. We also believe that we have intangible assets in the value ofour technology. In accordance with generally accepted accounting principles, wehave not capitalized the value of this intellectual property on ourconsolidated balance sheet. Due to the nature of this intellectual property, webelieve that these intangible assets are not affected by inflation. Because weintend to retain and continue to use our equipment, furniture and fixtures andleasehold improvements, we believe that the incremental inflation related toreplacement costs of such items will not materially affect our operations.However, the rate of inflation affects our expenses, such as those for employeecompensation and contract services, which could increase our level of expensesand the rate at which we use our resources.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls andProcedures**

 

As of the end ofthe period covered by this report, our management, with the participation ofour Chief Executive Officer and Chief Financial Officer, evaluated theeffectiveness of our disclosure controls and procedures pursuant to Rule 13a-15(b) promulgatedunder the Securities Exchange Act of 1934, as amended, or the Exchange Act.Based upon that evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded that, as of the evaluation date, our disclosure controls andprocedures were effective in ensuring that material information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms, includingensuring that such material information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding required disclosure.

 

**Changes in Internal Control OverFinancial Reporting**

 

During the periodcovered by this report, there have been no changes in our internal control overfinancial reporting that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

 

35

----

Table ofContents

 

**PART II. OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

None

 

**ITEM 1A. RISK FACTORS**

 

**Certain Factors Which May AffectFuture Results**

 

*Ouroperating results and financial condition have varied in the past and may inthe future vary significantly depending on a number of factors. Except for thehistorical information in this report, the matters contained in this reportinclude forward-looking statements that involve risks and uncertainties. Thefollowing factors, among others, could cause actual results to differmaterially from those contained in forward-looking statements made in thisreport and presented elsewhere by management from time to time. Such factors,among others, may have a material adverse effect upon our business, results ofoperations and financial condition.*

 

*In Part I. Item 1A (“Risk Factors”) of our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2007, which was filed with the Securities and Exchange Commission on March 17,2008, we describe risk factors related to the Company.  For convenience, our updatedrisk factors are included below in this Item 1A.  Other than the risk factors titled:*

 

·      ***Based on our currentcapital resources, including the proceeds from the Cephalon transactionreceived on November 3, 2008 and based on our current operating plans, wewill require significant additional capital to fund our operations through andbeyond the second quarter of 2009. There is substantial doubt as to our abilityto continue as a going concern.***

 

·      ***We need to allocate significant amounts of our availablecapital resources to make payments on our outstanding indebtedness andequipment lease obligations, our patent transfer agreement with******Bayer Schering Pharma AG, our patentlicense agreement with GE, our patent license agreement with Bracco and asdividends on our 6.5% convertible exchangeable preferred stock, which in turncould reduce our financial flexibility and ability to fund other activities.***

 

·      ***Failure to obtain regulatory approvals for our productcandidates under development, in particular our lead product candidate******Imagify, for which we missed endpoints in each ofour pivotal trials, would have a material adverse effect on our business.***

 

·      ***If Cephalon converts itsconvertible promissory note into the right to enter into an exclusive licensefor Imagify, we will have no other product candidates in active clinicaldevelopment.***

 

·      ***In connection with ourNovember 2008 transaction with Cephalon we granted Cephalon a securityinterest in substantially all of our assets, including our intellectualproperty, which could hinder our ability to secure additional debt financing.***

 

·      ***Under the terms of ourNovember 2008 agreement with Cephalon, we can not undertake certainspecified corporate actions without the consent of Cephalon, which couldfrustrate our ability to raise equity or debt or enter into futurecollaboration agreements, among other things.***

 

·      ***FDA has required warning labels be added to product labelingfor certain contrast agents as a result of serious adverse events and, ifapproved, our Imagify product candidate may require similar labeling.***

 

·      ***We may need to enroll more patients in future clinicaltrials, and any such additional enrollment would require additionalexpenditures, which may be material, and would likely result in a delay ofultimate approval of the  for******Imagify.***

 

·      ***We have never manufactured any of our product candidates incommercial quantities, and if we fail to develop an effective manufacturingcapability for our products, including our lead product candidate******Imagify, we may be unable to commercialize theseproducts.***

 

·      ***We may not be able to manufacture our products in commercialquantities, which would prevent us from marketing our products.***

 

·      ***Materials necessary to manufacture our products may not beavailable, which may delay our development and commercialization activities.***

 

·      ***Competition in the pharmaceutical industry is intense, andif we fail to compete effectively our financial results will suffer.***

 

·      ***Our products involve theuse of hazardous materials, and as a result we are exposed to potentialliability claims and to costs associated with complying with laws regulatinghazardous waste.***

 

·      ***Our common stock may be delistedfrom the Nasdaq Capital Market, which could negatively impact the price of ourcommon stock and our ability to access the capital markets.***

 

·      ***If Cephalon elects toconvert its convertible promissory into shares of our common stock, it willlikely result in immediate and substantial dilution to our stockholders andpotentially give Cephalon control over stockholder votes.***

 

36

----

Tableof Contents

 

·      ***If Cephalon elects toconvert its convertible promissory into shares of our common stock, it willhave the right to proportional representation on our board of directors, whichwould provide Cephalon with an opportunity to exert significant control over thestrategic direction of Acusphere.***

 

·      ***Ifshares under our universal shelf registration statement are issued, then theprice of our securities may be negatively affected.***

 

·      ***Our common stock is junior to our preferred stock withrespect to the right to receive payments in the event of a dissolution,liquidation or winding up of Acusphere.***

 

·      ***Future sales of common stock by our existing stockholdersmay cause our stock price to fall.***

 

·      ***The terms of our outstanding shares of preferred stock mayrestrict our ability to raise additional capital or hamper or prevent anacquisition of us.***

 

·      ***Under some circumstances, the holders of our outstandingshares of preferred stock may be entitled to elect some of the directors ofAcusphere.***

 

·      ***In connection with our November 2008transaction with Cephalon we waived Section 203 of the Delaware GeneralCorporation Law and agree to seek shareholder approval of certain provisions ofour certificate of incorporation, which may make it more difficult todiscourage an acquisition of Acusphere by Cephalon or others.***

 

***t****here have been nomaterial changes in our risk factors from those disclosed in Part I. Item1A of our Annual Report on Form 10-K for the fiscal year ended December 31,2007.*

 

**Risks Related to Our Company**

 

***Basedon our current capital resources, including the proceeds from the Cephalontransaction received on November 3, 2008 and based on our currentoperating plans, we will require significant additional capital to fund ouroperations through and beyond the second quarter of 2009.******Thereis substantial doubt as to our ability to continue as a going concern.***

 

We are focused onproduct development and we have not generated any revenue from commercial salesof our products to date. We have incurred losses each year of our operations.For the nine months ended September 30, 2008, we had a net loss availableto 

 

37

----

Table ofContents

 

holders of common stockof $36.3 million. At September 30,2008 we had an accumulated deficit of $369.7 million. We expect ourresearch and development, general and administrative and sales and marketingexpenses will increase over the next several years.

 

We expect to continueto incur losses and capital expenditures for the foreseeable future. We alsoanticipate cash outflow from debt repayment and payment of other obligations,including dividends payable on our outstanding shares of 6.5% convertibleexchangeable preferred stock. Proceeds from the Cephalon transaction receivedon November 3, 2008 and based on our operating plans, we will requiresignificant additional capital to fund our operations through and beyond thesecond quarter of 2009, including developing products, conducting clinicaltrials, achieving regulatory approvals, qualifying commercial manufacturingspace and, subject to regulatory approval, commercially launching Imagify, orother product candidates under development or future product candidates. We mayraise this additional capital through public or private sales of equity, orfrom borrowings, or from strategic partners.

 

As a result of ourlimited capital resources, we have elected and may continue to elect to delaythe funding of certain development activities which would result in a delay inthe approval and/or commercialization of Imagify. Any such delay in approvaland/or commercialization of Imagify would have a material adverse impact on ourbusiness and would likely have a material adverse effect on the market price ofour common stock. To address our capital needs, we may elect to raise fundsthrough public or private sales of equity or from borrowings or from strategicpartners. Additional equity financing, if available, will be dilutive to our stockholders;debt financing, if available, may involve significant cash payment obligationsand covenants that restrict our ability to operate our business; and strategicpartnerships, if available, may result in royalties or other terms which reduceour economic potential from products under development. In addition, thirdparties may attempt to acquire us at valuations our board of directors orstockholders may not find attractive. Since our present capital resources are not sufficient to fund ourplanned operations for a twelve month period as of the date of this QuarterlyReport on Form 10-Q, our current financial resources raise substantialdoubt about our ability to continue as a going concern.

 

We cannot assureyou that we can obtain additional funding on reasonable terms, or at all. If weraise additional funds by issuing equity securities, our stock price maydecline, our existing stockholders will experience significant dilution, andthe newly issued securities may have rights superior to those of our commonstock. If we raise additional funds by issuing debt, we may be subject tolimitations on our operations and such debt may have rights senior to thedebentures, if issued. If we cannot obtain adequate funds, we may:

 

·terminate or delay clinical trials for one or more of our product candidates;

·delay our establishment of sales, marketing and/or manufacturing capabilities;

·curtail significant product development programs that are designed to identifynew product candidates;

·relinquish rights to our technologies or product candidates;

·terminate or delay qualification of our commercial manufacturing facility;and/or

·terminate or delay development of one or more of our product candidates,including Imagify, and discontinue operations of all or a portion of ouroperations.

 

***We need to allocate significant amounts of our availablecapital resources to make payments on our outstanding indebtedness andequipment lease obligations, our patent transfer agreement with******Bayer Schering Pharma AG******, ourpatent license agreement with GE, our patent license agreement with Bracco andas dividends on our 6.5% convertible exchangeable preferred stock, which inturn could reduce our financial flexibility and ability to fund otheractivities.***

 

As of November 1,2008, we had approximately $14.6 million in aggregate principal indebtednessoutstanding related to capital lease obligations, notes payable, accrueddividends and other long-term obligations.****As of November 6,2008, we had outstanding 310,000 shares of our 6.5% convertible exchangeablepreferred stock, which shares accrue cumulative cash dividends at the annualrate of $3.25 per share, payable quarterly on the first day of March, June,September, and December. These payments will:

 

·                  reduce the availability of our capital to fund our clinical trials forImagify, the qualification of our commercial manufacturing space in Tewksbury,Massachusetts and for working capital and other general corporate purposes andmay require us, in order to meet these obligations, to delay or reduceexpenditures or forego business opportunities; and

·                  potentially impair our ability to obtain additional financing.

 

To address ourcapital needs, we may elect to raise funds through public or private sales of equityor from borrowings or from strategic partners. Additional equity financing, ifavailable, will be dilutive to our stockholders; debt financing, if available,may involve significant cash payment obligations and covenants that restrictour ability to operate as a business; and strategic partnerships, if available,may result in royalties or other terms which reduce our economic potential fromproducts under development.

 

38

----

Table ofContents

 

***Failure to obtain regulatory approvals for our productcandidates under development, in particular our lead product candidate******Imagify, for which wemissed endpoints in each of our pivotal trials******,would have a material adverse effect on our business.***

 

We must receiveregulatory approval of each of our product candidates before we cancommercialize or sell that product candidate. The pre-clinical laboratorytesting, formulation development, manufacturing and clinical trials of anyproduct candidates we develop independently or in collaboration with thirdparties, as well as the distribution and marketing of these product candidates,are regulated by numerous federal, state and local governmental authorities inthe United States, principally FDA, and by similar agencies in other countries.The development and regulatory approval process takes many years, requires theexpenditure of substantial resources, is uncertain and subject to delays, andcould thus delay our receipt of revenues, if any, from any of our productcandidates.

 

The data obtainedfrom clinical and pre-clinical activities are subject to varyinginterpretations that could delay, limit or prevent regulatory agency approval.In particular, we can not assure you that our Imagify clinical results willsuccessfully address FDA requirements sufficiently for us to obtain regulatoryapproval. No product can receive FDA approval unless human clinical trials showboth safety and efficacy for each target indication in accordance with FDAstandards. FDA analysis of results include both quantitative and qualitativeanalysis. In both our RAMP-1 and RAMP-2 clinical trial results, we achieved theprincipal primary endpoint of accuracy but failed to achieve one of the twocomponent primary endpoints in each trial (sensitivity in RAMP-1 andspecificity in RAMP-2).  The FDA may lookat these trials separately rather than in their totality and may not approveImagify based upon these missed endpoints. We cannot predict whether FDA willapprove Imagify based upon the available results or whether FDA will seekadditional data as a condition to approval or whether they will approve Imagifyat all. FDA has announced that the NDA for Imagify will be discussed by theCardiovascular and Renal Drugs Advisory Committee at their meeting on December 10th,2008. We cannot predict the outcome of these discussions, the advice that maybe given to FDA or the impact on approvability of Imagify or the timingthereof.

 

Our RAMP-1 andRAMP-2 clinical trial results are based upon our statistical analysis plans forthose trials. These statistical analysis plans, including calculations ofstatistical significance, were created based on a variety of factors, includingfeedback from our discussions with FDA, the input of our regulatory consultantsand our own knowledge and past experience in these and similar matters. Weanticipate that the FDA will evaluate the quality and independence of themanner in which our Imagify clinical trials were conducted. In recent years,other companies seeking approval for their contrast agents have encountereddifficulties convincing FDA that the comparative or truth standards that theyused in their clinical trials met acceptable levels of quality, consistency orother standards acceptable to the FDA. In such cases, these issues werereported to be contributing factors in the failure of such product candidatesto be approved. If the FDA, upon review, has concern about the manner in whichour RAMP-1 or RAMP-2 trials were conducted, or has concerns about the resultsof the nuclear stress tests or coronary angiography used as a comparator andtruth standard in these trials, this could delay or prevent FDA approval ofImagify based upon our current trial results. There can be no assurance thatFDA will accept our statistical analysis without modification.  How, when, or if such matters are resolvedmay affect whether Imagify is approved for the indication that we are seeking,the timing of such approval, or whether Imagify is approved at all.   In addition, in conjunction with approvingproducts, it is common for regulatory agencies to impose limits on how suchproducts can be used and marketed.  We anticipate that if and when Imagifyand other product candidates are approved that the initial use and marketing ofthese products may be limited at least until such time as we conduct additionalclinical studies or information otherwise becomes available to address theunderlying reasons for such limitations.

 

We may encounterdelays or rejections based on changes in regulatory agency policies orpersonnel during the period in which we develop a drug or the period requiredfor review of any application for regulatory agency approval of a particularcompound. Our continuing efforts to comply with these changes could lead todelays or rejections of our clinical trials. We also may encounter delays inthe event we are unable to produce clinical trial material in sufficientquantities and of sufficient quality to meet the schedule for our plannedclinical trials. In addition, we rely on a number of third parties, such asclinical research organizations, to help support the clinical trials byperforming independent clinical monitoring, data acquisition and data evaluations.Any failure on the part of these third parties could delay the regulatoryapproval process.

 

Failure to obtainregulatory approval or any delay or setback in obtaining regulatory agencyapprovals could:

 

·adversely affect our ability to market any drugs we develop independently orwith collaborative partners;

·impose additional costs and diminish any competitive advantages that we mayattain; or

·adversely affect our ability to generate royalties.

 

39

----

Table ofContents

 

Failure to obtainapproval for our lead product candidate, Imagify, or delay in such approval,would delay our receipt of product revenues and would have a material adverseaffect our business, financial condition and results of operations.  Our stock price would also be materiallyadversely affected.

 

***IfCephalon converts its convertible promissory note into the right to enter intoan exclusive license for Imagify, we will have no other product candidates inactive clinical development.***

 

If Cephalon converts theits convertible promissory note into the right to enter into an exclusivelicense for Imagify, we will no longer have any right to commercialize Imagifyand will thereafter only be entitled to receive milestone and royalty paymentsfrom our licensees in connection with the sale of Imagify.  We currently have no product candidates inactive clinical development. Any future product candidate we may develop wouldrequire many years of pre-clinical and clinical development, regulatoryapproval and substantial additional resources, before we could commercializethat product candidate.

 

***In connection with our November 2008 transaction with Cephalon wegranted Cephalon a security interest in substantially all of our assets,including our intellectual property, which could hinder our ability to secureadditional debt financing.***

 

In connection with our November 2008 transaction with Cephalon, weissued Cephalon a $15 million senior secured convertible note and grantedCephalon a security interest in substantially all of our assets, including ourintellectual property, to secure our obligations under the convertible note. TheCephalon convertible note is subject to acceleration and an increased interestrate upon the happening of customary events of default, including the failureto make timely payments of principal and interest.  Cephalon would have the right to realize on thesesecured assets to satisfy amounts owed under the note in an event ofdefault.  If Cephalon were to realize onthese secured assets, especially our intellectual property rights, it wouldhave a material adverse effect on our business.

 

In addition, because wehave now granted a security interest in all of our assets to Cephalon and otherlenders, it may become more difficult for us to raise additional debt to fundour continued operations.

 

***Underthe terms of our November 2008 agreement with Cephalon, we can notundertake certain specified corporate actions without the consent of Cephalon,which could frustrate our ability to raise equity or debt or enter into futurecollaboration agreements, among other things.***

 

Pursuant to the terms ofour note purchase agreement with Cephalon, we are not permitted to undertakecertain specified corporate actions, such as issue additional equity securitiesor securities convertible into equity securities, enter into a material jointventure or partnership with a third party, incur additional indebtedness, enterinto the sale of the Company, or amend our certificate of incorporation orbylaws, for so long as the Cephalon convertible note remains outstanding orCephalon holds at least 25% or more of our outstanding voting securities, whichperiod we refer to as the restricted period, without the prior consent ofCephalon.  Cephalon’s control over ourability to enter into certain of these corporate actions may frustrate ourability to issue additional equity or debt securities or enter into futurecollaborations related to our products.

 

***Adverseevents are likely to be encountered in our clinical trials and these eventscould delay, limit or prevent regulatory approval.***

 

Many of thepatients in our Imagify clinical trials have coronary artery disease. As partof our Imagify clinical trials, patients are exposed to potential safety risksassociated with a stress test, including risks associated with apharmacological stressor, and Imagify. Given the nature of the Imagify clinicaltrials, including the cumulative administration of Imagify to larger numbers ofat-risk patients and administering Imagify to patients with coexisting disease,adverse events are expected to be encountered during any future clinicaltrials. Adverse events are also likely to be encountered in clinical trials forour other products, which clinical trials may also include at-risk patients.When significant adverse events are detected and these events are attributableto our products, such events could delay, limit or prevent regulatory agencyapproval.

 

***FDA has required warning labels be added to product labelingfor certain contrast agents as a result of serious adverse events and, ifapproved, our Imagify product candidate may require similar labeling.***

 

FDA has required warning labels to be added toproduct labeling for certain ultrasound contrast agents which are approved foruse in clinically unstable and acutely ill patients. These FDA-approved agents, Optison,marketed by GE Healthcare and Definity, marketed by Lantheus Medical Imaging, are injected intopatients prior to a cardiac ultrasound to improve visibility of theimage. While we believe that Imagify is structurally different from thesecommercially-available ultrasound contrast agents, we cannot assure you that, 

 

40

----

Table ofContents

 

if approved,Imagify will not be required to carry a similar warning.  As a result, the potential market size may besignificantly smaller.

 

***Ourcollaborative partners may not obtain regulatory approvals in other countries,which may have an adverse effect on our business.***

 

We cannot becertain that we or our partners will obtain any regulatory approvals in othercountries and the failure to obtain these approvals would have a materialadverse affect on our business, financial condition and results of operations.In order to market our products outside of the United States, we and ourcurrent, and potential future, collaborative partners must establish and complywith numerous and varying regulatory requirements of other countries regardingsafety and efficacy. The approval procedures vary among countries and caninvolve additional product testing and additional administrative reviewperiods. The time required to obtain approval in other countries might differfrom that required to obtain FDA approval. The regulatory approval process inother countries may include all of the risks associated with obtaining FDAapproval detailed above. Approval by FDA does not ensure approval by theregulatory authorities of other countries. In addition, many countries outsidethe United States require a separate review process prior to marketing todetermine whether their national health insurance schemes will pay for newlyapproved products, as well as the price which may be charged for a product.

 

***We may need to enroll more patients in future clinicaltrials, and any such additional enrollment would require additionalexpenditures, which may be material, and would likely result in a delay ofultimate approval of the  for******Imagify******.***

 

If discussionswith FDA lead us to conclude that further clinical trials of Imagify arerequired to achieve NDA approval, such trials may affect the timing of suchultimate approval and we would incur significant additional costs.  We cannot assure that the performance ofadditional trials would lead ultimately to NDA approval.  Moreover, we currently do not possesssufficient inventory of Imagify to conduct any such trial, and would need tocontract for the manufacture of such material. We may not be able to obtain sufficient quantity of such material in atimely fashion or on commercially reasonable terms, or at all.  Our inability to conduct additional clinicaltrials for Imagify in a timely fashion, or at all, resulting from of ourinability to manufacture or obtain clinical trial materials would have materialadverse effect on our business.

 

***If we cannot raise additional capital on acceptable terms,we may be unable to complete planned clinical trials, obtain regulatoryapprovals or commercialize our product candidates.***

 

We will requiresubstantial future capital in order to continue to conduct the research anddevelopment, clinical and regulatory activities necessary to bring our productcandidates to market and to establish commercial manufacturing, marketing andsales capabilities. Our future capital requirements will depend on manyfactors, including the:

 

·progress of pre-clinical development and laboratory testing and clinicaltrials;

·timing of construction and size to which we expand our manufacturingcapabilities;

·time and costs involved in obtaining regulatory approvals;

·number of product candidates we pursue;

·costs involved in filing and prosecuting patent applications and enforcing ordefending patent claims; and

·establishment of selected strategic alliances and activities required forproduct commercialization.

 

We may seekadditional funding through strategic collaborations or through private orpublic sales of our securities or by licensing all or a portion of ourtechnology. This funding will significantly dilute existing stockholders or maylimit our rights to our technology.  Anyof these could have a material adverse effect on our business, financialcondition and results of operations.  Ourstock price could also be materially adversely affected.

 

***Our products, ifapproved, may fail to achieve market acceptance.***

 

There can be noassurance that any products we successfully develop, if approved for marketing,will achieve market acceptance or generate significant revenues. Each of ourproduct candidates is intended to replace or alter existing therapies orprocedures, and hospitals, physicians or patients may conclude that theseproducts are less safe or effective or otherwise less attractive than theseexisting therapies or procedures. For example, our lead product candidate,Imagify, is a cardiovascular drug for use in ultrasound imaging procedureswhich will compete with existing nuclear imaging and cardiac ultrasound.Hospitals, physicians or patients may prefer these existing procedures toImagify perfusion stress ultrasound imaging. If our products do not receivemarket acceptance for any reason, it would adversely affect our business,financial condition and results of operations. In such event, we may elect to 

 

41

----

Table ofContents

 

conduct additionalclinical trials designed to demonstrate the effectiveness of Imagify incircumstances not studied in our Phase 3 clinical trials.  Any such studies will likely be expensive andtime consuming. Further, our competitors may develop new technologies orproducts that are more effective or less costly, or that seem morecost-effective, than our products. We can give no assurance that hospitals,physicians, patients or the medical community in general will accept and useany products that we may develop.

 

***We have never manufactured any of our product candidates incommercial quantities, and if we fail to develop an effective manufacturingcapability for our products, including our lead product candidate******Imagify******, wemay be unable to commercialize these products.***

 

We have noexperience in manufacturing our products for commercial use and limitedexperience in designing equipment for the manufacture of our products. We areworking to qualify operations at a commercial manufacturing facility inTewksbury, Massachusetts and to demonstrate that we can produce Imagify at acommercial manufacturing scale, and subject to required regulatory approvals,we intend to manufacture Imagify in this facility for commercial use. We cannot assure you that we will be able to obtain the necessary regulatoryapprovals for such commercial manufacture, at all or in a timely or economicalmanner. Our intention to manufacture Imagify or other products exposes us tothe following risks, any of which could delay or prevent the approval of ourproducts by FDA or corresponding state and foreign agencies, or thecommercialization of our products, or result in higher costs or inability tomeet demand for Imagify leading to potential revenue loss, and any of whichwould have a material adverse impact on our business, financial condition andresults of operations.

 

·Manufacturers are obliged to manufacture in highly controlled environments andto operate in accordance with FDA and international mandated current goodmanufacturing practices, or cGMPs. For our clinical trials we have relied oncontract manufacturers for such facilities and cGMP compliance. Creation andqualification of a commercial manufacturing environment requires significantexpertise and capital resources, including the development of advancedmanufacturing techniques and process controls and is subject to local and stateplanning approvals. Manufacturers of pharmaceutical products often encounterdifficulties in constructing and qualifying new manufacturing facilities and inproduction, especially in scaling-up initial production. A failure to establishand follow cGMPs and to document adherence to such practices may lead tosignificant delays in the availability of material for commercial productionfor Imagify and may delay or prevent filing or approval of marketingapplications for our products or the ability to continue to manufacture theproducts. Certain of these delays would further require us to continue tooperate this facility and incur related costs.

 

·Manufacture of our product candidates, in preparation for commercialproduction, will each initially require and rely on a single commercialmanufacturing site, directly or through a contract manufacturer, without thebackup of a second site that is qualified for commercial manufacture of theproduct. Qualification of another manufacturing site can be expensive and timeconsuming. Prior to using product from a new manufacturing site, we mustdemonstrate to FDA and corresponding state and foreign agencies that thespecifications for the product are consistent with the specifications for theproduct as it was manufactured at a prior qualified site or we must clinicallyor otherwise demonstrate that the safety and efficacy of the product producedin the new manufacturing site is consistent with the product as it wasmanufactured at the prior site. Demonstrating such consistency may bedifficult, expensive or time consuming. In addition, before we would be able toproduce product for commercial use at a new facility, it will have to undergo apre-approval inspection by FDA and corresponding state and foreign agencies.Once approved, drug manufacturers are subject to ongoing periodic unannouncedinspection by FDA and corresponding state and foreign agencies to ensure strictcompliance with cGMPs, other government regulations and corresponding foreignstandards. Failure to maintain compliance with cGMP or with safety orenvironmental regulations could result in penalties, product recalls orrestrictions on the use of the manufacturing site.

 

We have a singlemanufacturing facility. This facility and the manufacturing equipment we use toproduce Imagify would be difficult to replace and could require substantiallead-time to repair or replace in the event of a regulatory, manufacturing,catastrophic event or similar problem. In such event, we would be forced torely on third-party manufacturers and there would likely be substantial delaybefore we would be able to restart production. Although we possess insurance fordamage to our property and the disruption of our business from casualties, suchinsurance may not be sufficient to cover all of our potential losses, includingpotential damage to our reputation, and may not continue to be available to uson acceptable terms, or at all. In addition, future growth may outpace ourmanufacturing capacity, in which event we would need to locate, obtain andbuild-out additional space. New or alternative facilities may not be availableto us on acceptable terms. Even if we are able to identify such new oralternative facilities, we may incur additional costs and we may experience adisruption in the supply of our products until those facilities are available.

 

42

----

Table ofContents

 

***Failure to manufacture our products in commercial quantitiesor at commercially reasonable rates could damage our European partnership.***

 

Under the terms ofour collaboration agreement with Nycomed, we are responsible for the commercialmanufacture of Imagify for marketing and sale by Nycomed in Europe. Failure tomanufacture Imagify in a timely manner or on an economic basis, or insufficient quantities, could jeopardize our relationship with Nycomed. We donot currently have a European sales force, nor do we have experience withregard to the commercialization, marketing, sale or distribution ofpharmaceutical products in Europe, and we rely entirely on Nycomed for thisexpertise. Any termination of our relationship with Nycomed would have amaterial adverse impact on our business, financial condition and results ofoperations.

 

***We may not be ableto manufacture our products in commercial quantities, which would prevent usfrom marketing our products.***

 

To date ourproduct candidates have been manufactured in small quantities for pre-clinicaland clinical trials. If any of these product candidates are approved by FDA orforeign regulatory authorities for commercial sale, we will need to manufacturethem in larger quantities. For Imagify, we are seeking regulatory approvalafter we have demonstrated that we can manufacture Imagify at a larger batchscale than is being used for clinical trial materials. However, manufacturersoften encounter difficulties in achieving volume production, quality controland quality assurance and we might not be able to manufacture sufficientquantities of drugs to meet our clinical schedules or to commercialize ourproducts.  We cannot assure you that wewill be able to successfully increase the manufacturing capacity or manufactureat a larger batch scale, whether on our own or in collaboration with thirdparty manufacturers, for any of our product candidates in a timely or economicmanner, or at all. Significant scale-up of manufacturing may require certainadditional validation studies, which FDA must review and approve. If we areunable to successfully increase the manufacturing capacity for a productcandidate, the regulatory approval or commercial launch of that productcandidate may be delayed or there may be a shortage in supply of that productcandidate. Our product candidates require precise, high-quality manufacturing.Our failure to achieve and maintain these high manufacturing standards,including controlling the incidence of manufacturing errors and maintainingreliable product packaging for diverse environmental conditions, could resultin patient injury or death, product recalls or withdrawals, delays or failuresin product testing or delivery, cost overruns or other problems that couldseriously hurt our business.

 

Our commercialmanufacturing facility in Tewksbury, Massachusetts is designed to meet ourestimated initial commercial demand for Imagify. The facility is being initiallyequipped to run one production line. In order to support greater productioncapacity, this production line is designed to support a larger lyophilizer(pharmaceutical freeze dryer which can be operated under sterile conditions) inaddition to the one that has been initially installed. Purchasing, installingand qualifying manufacturing equipment, such as a lyophilizer, typicallyrequires significant lead times and temporary discontinuation of production.Also in the future we may need to add additional production lines at theTewksbury site or elsewhere to meet potential commercial demand for Imagify. Wehave made no commitment to such additions at this time. The cost of suchadditions can be significant. There can be no assurance that our capacity estimateswill be achieved. Any such additions would increase our operating spending,increase our capital requirements and reduce our resources available fordevelopment activities.

 

***We have removed our******Imagify******manufacturing equipment from the facilities of our third party contractmanufacturer and currently have no facility within which to manufacture******Imagify******untilthe new commercial manufacturing facility is qualified or until otherarrangements are made.***

 

We have removedour Imagify manufacturing equipment from the facilities of a third-partycontract manufacturer.  Currently, wehave no facility within which to manufacture Imagify until the new commercialmanufacturing facility is qualified or until other arrangements are made. Wehave no existing inventory of Imagify on-hand and would need to produce, orcontract with a third party for the production of additional material forfuture clinical trials. If we are not able to secure sufficient inventory ofImagify clinical trial material to perform clinical trials, our program couldbe adversely impacted or delayed. These delays could have a material adverseeffect on our business, financial condition and results of operations.

 

***If third-party manufacturers of our products candidates failto devote sufficient time and resources to our concerns, or if theirperformance is substandard, our clinical trials may be delayed and our costsmay rise.***

 

We may relysubstantially on third-party contract manufacturers to supply, store anddistribute our product candidates for our clinical trials and other developmentneeds. Our reliance on these third-party manufacturers will expose us to thefollowing risks, any of which could delay or prevent the completion of ourclinical trials, the approval of our products by FDA, or the commercializationof our 

 

43

----

Table ofContents

 

products, resultin higher costs, or deprive us of additional product candidates, and any ofsuch effects would have a material adverse impact on our business, financialcondition and results of operations.

 

·Contract manufacturers often encounter difficulties in achieving volumeproduction, quality control and quality assurance, as well as shortages ofqualified personnel. Accordingly, a manufacturer might not be able tomanufacture sufficient quantities of drugs to meet our clinical schedules.

 

·Contract manufacturers are obliged to operate in accordance with FDA-mandatedcurrent good manufacturing practices, or cGMPs. A failure of these contractmanufacturers to establish and follow cGMPs and to document their adherence tosuch practices may lead to significant delays in the availability of materialfor clinical study and may delay or prevent filing or approval of marketingapplications for our products.

 

·For production of clinical trial material for each of our current productcandidates we will initially rely on a single manufacturer. Changing these orfuture manufacturers may be difficult and the number of potential manufacturersis limited. Changing manufacturers may require re-validation of the manufacturingprocesses and procedures in accordance with FDA-mandated cGMPs. Suchre-validation may be costly and time-consuming. It may be difficult orimpossible for us to find replacement manufacturers on acceptable termsquickly, or at all.

 

·Our contract manufacturers may not perform as agreed or may not remain in thecontract manufacturing business for the time required to produce, store anddistribute our products successfully. Our manufacturing levels, while importantto us, can represent relatively small fractions of the overall business of mostqualified contract manufacturers. As a result, the contract manufacturers maynot provide us with the attention that we need or may be unwilling to adapt tonecessary changes in our manufacturing requirements.

 

Drug manufacturersare subject to ongoing periodic unannounced inspection by FDA and correspondingstate and foreign agencies to ensure strict compliance with cGMPs, othergovernment regulations and corresponding foreign standards. While we areobligated to audit the performance of third party contractors, we do not havecontrol over our third-party manufacturers’ compliance with these regulationsand standards. Failure by our third-party manufacturers or us to comply withapplicable regulations could result in sanctions being imposed on us, includingfines, injunctions, civil penalties, failure of the government to grant marketapproval of drugs, delays, suspension or withdrawal of approvals, seizures orrecalls of product, operating restrictions and criminal prosecutions, any ofwhich could significantly and adversely affect our business.

 

***Materials necessary to manufacture our products may not beavailable, which may delay our development and commercialization activities.***

 

Only a few facilitiesmanufacture some of the raw materials necessary to manufacture our products. Ifwe need to purchase a raw material that is in limited supply or becomesunavailable for our clinical trials, or for commercial distribution if weobtain marketing approval of a product candidate, we cannot assure you thatsuppliers would be able to sell us that raw material at the time we need it andon commercially reasonable terms. If we change suppliers for any of thesematerials or any of our suppliers experiences a shutdown or disruption in thefacilities used to produce these materials, due to technical, regulatory orother problems, it could harm our ability to manufacture our products orreceive regulatory approval.

 

***We have noexperience selling, marketing or distributing our products and no internalcapability to do so.***

 

If we receiveregulatory approval to commence commercial sale of any product, we will facecompetition with respect to commercial sales, marketing and distribution. Theseare areas in which we have no experience. To market any of our productsdirectly, we must develop a direct marketing and sales force with technicalexpertise and supporting distribution capability. Alternatively, we may engagea pharmaceutical or other healthcare company with an existing distributionsystem and direct sales force to assist us. There can be no assurance that wewill successfully establish sales and distribution capabilities either on ourown or in collaboration with third parties or gain market acceptance for ourproducts. To the extent we have or will enter co-promotion or other licensingarrangements, any revenues we receive will depend on the efforts of thirdparties and there can be no assurance that our efforts will succeed.

 

***Our potentialproduct trade names may not be acceptable to FDA.***

 

FDA reserves theright to approve product names prior to commercialization.  We have proposed to FDA the tradenameImagify, as well as an alternative tradename, as a potential product trade namefor our lead product.  FDA has raisedconcerns regarding the name 

 

44

----

Table ofContents

 

Imagify which, ifnot resolved, could cause us to use the alternative name which FDA findsacceptable.  Trade names changes couldresult in additional cost to us and could adversely affect our preparations forcommercialization of this product which could, in turn, adversely affect ourbusiness, financial condition and results of operations.

 

***Claims by other parties that we infringe or havemisappropriated their proprietary technology may result in liability fordamages, royalties, or other payments, or stop our development andcommercialization efforts.***

 

Competitors andother third parties may initiate patent litigation against us in the UnitedStates or in foreign countries based on existing patents or patents that may begranted in the future. Many of our competitors have obtained patents coveringproducts and processes generally related to our products and processes, andthey may assert these patents against us. Moreover, there can be no assurancethat these competitors have not sought or will not seek additional patents thatmay cover aspects of our technology. As a result, there is a greater likelihoodof a patent dispute than would be expected if our competitors were pursuingunrelated technologies.

 

While we conductpatent searches to determine whether the technologies used in our productsinfringe patents held by third parties, numerous patent applications arecurrently pending and may be filed in the future for technologies generallyrelated to our technologies, including many patent applications that remainconfidential after filing. Due to these factors and the inherent uncertainty inconducting patent searches, there can be no guarantee that we will not violatethird-party patent rights that we have not yet identified.

 

We know of U.S.and foreign patents issued to third parties that relate to aspects of ourproduct candidates. There may also be patent applications filed by these orother parties in the United States and various foreign jurisdictions thatrelate to some aspects of our product candidates, which, if issued, couldsubject us to infringement actions. In particular, we are aware of U.S. andforeign patents owned by third parties, including potential competitors, whicharguably cover aspects of our Imagify contrast agent. We and several of theseparties have been actively engaged in opposing the grant of European patentswith claims that arguably cover aspects of our Imagify product. Parties maycontest patents in Europe prior to contesting the counterpart patents in theUnited States because of procedural differences between European and U.S.patent laws as well as economic considerations.

 

The owners orlicensees of these and other patents may file one or more infringement actionsagainst us. In addition, a competitor may claim misappropriation of a tradesecret by an employee hired from that competitor. Any such infringement ormisappropriation action could cause us to incur substantial costs defending thelawsuit and could distract our management from our business, even if theallegations of infringement or misappropriation are unwarranted. A need todefend multiple actions or claims could have a disproportionately greaterimpact. In addition, either in response to or in anticipation of any suchinfringement or misappropriation claim, we may enter into commercial agreementswith the owners or licensees of these rights. The terms of these commercialagreements may include substantial payments, including substantial royaltypayments on revenues received by us in connection with the commercialization ofour products. Payments under such agreements could increase our operatinglosses and reduce our resources available for development activities.Furthermore, a party making this type of claim could secure a judgment thatrequires us to pay substantial damages, which would increase our operatinglosses and reduce our resources available for development activities. Ajudgment could also include an injunction or other court order that couldprevent us from making, using, selling, offering for sale or importing ourproducts or prevent our customers from using our products. If a courtdetermined or if we independently concluded that any of our products ormanufacturing processes violated third-party proprietary rights, our clinicaltrials could be delayed and there can be no assurance that we would be able toreengineer the product or processes to avoid those rights, or to obtain alicense under those rights on commercially reasonable terms, if at all.

 

***If we are unable to protect our intellectual propertyrights, our competitors may develop and market products with similar featuresthat may reduce demand for our products, and we may be prevented fromestablishing collaborative relationships on favorable terms.***

 

The followingfactors are important to our success:

 

·receiving patent protection for our product candidates;

·maintaining our trade secrets;

·not infringing on the proprietary rights of others; and

·preventing others from infringing our proprietary rights.

 

We will be able toprotect our proprietary rights from unauthorized use by third parties only tothe extent that our proprietary rights are covered by valid and enforceablepatents or are effectively maintained as trade secrets.

 

45

----

Table ofContents

 

We try to protectour proprietary position by filing U.S. and foreign patent applications relatedto our proprietary technology, inventions and improvements that are importantto the development of our business. Because the patent position of pharmaceuticalcompanies involves complex legal and factual questions, the issuance, scope andenforceability of patents cannot be predicted with certainty. Patents, ifissued, may be challenged, invalidated or circumvented. Thus, any patents thatwe own or license from others may not provide any protection againstcompetitors. Our pending patent applications, those we may file in the future,or those we may license from third parties, may not result in patents beingissued. If issued, they may not provide us with proprietary protection orcompetitive advantages against competitors with similar technology.Furthermore, others may independently develop similar technologies or duplicateany technology that we have developed. The laws of many foreign countries donot protect our intellectual property rights to the same extent as do the lawsof the United States.

 

We also rely ontrade secrets, know-how and technology, which are not protected by patents, tomaintain our competitive position. We try to protect this information byentering into confidentiality agreements with parties that have access to it,such as our corporate partners, collaborators, employees and consultants. Anyof these parties may breach the agreements and disclose our confidentialinformation or our competitors might learn of the information in some otherway. If any trade secret, know-how or other technology not protected by apatent were to be disclosed to or independently developed by a competitor, ourbusiness and financial condition could be materially adversely affected.

 

***We may become involved in lawsuits and administrativeproceedings to protect, defend or enforce our patents that would be expensiveand time consuming.***

 

In order toprotect or enforce our patent rights, we may initiate patent litigation againstthird parties in the United States or in foreign countries. In addition, wehave been and continue to be subject to certain opposition proceedingsconducted in patent and trademark offices challenging the validity of ourpatents and may become involved in future opposition proceedings. The defenseof intellectual property rights, including patent rights through lawsuits,interference or opposition proceedings, and other legal and administrativeproceedings can be costly and can divert our technical and management personnelfrom their normal responsibilities. Such costs increase our operating lossesand reduce our resources available for development activities. An adversedetermination of any litigation or defense proceedings could put one or more ofour patents at risk of being invalidated or interpreted narrowly and could putour patent applications at risk of not issuing.

 

Furthermore,because of the substantial amount of discovery required in connection withintellectual property litigation, there is a risk that some of our confidentialinformation could be compromised by disclosure during this type of litigation.For example, during the course of this kind of litigation and despiteprotective orders entered by the court, confidential information may beinadvertently disclosed in the form of documents or testimony in connectionwith discovery requests, depositions or trial testimony. This disclosure couldmaterially adversely affect our business and financial results.

 

***If we are unable to retain key personnel and hire additionalqualified scientific, manufacturing, sales and marketing, and other personnel,we may not be able to successfully achieve our goals.***

 

We depend on theprincipal members of our scientific and management staff. The loss of theseprincipal members’ services might significantly delay or prevent theachievement of research, development or business objectives and couldmaterially adversely affect our business, financial condition and results ofoperations. We do not maintain key person life insurance on any of theseprincipal members, except for the CEO.  We have entered into executiveemployment agreements, as amended, with key members of the management team thatprovide for compensation and other benefits in the event these persons areterminated other than for cause, including in connection with a “change ofcontrol” of Acusphere, or if they terminate their employment for good reason.

 

Our successdepends, in large part, on our ability to attract and retain qualified scientificand management personnel such as these individuals. We face intense competitionfor such personnel and consultants. We cannot assure you that we will attractand retain qualified management and scientific personnel in the future.

 

Further, we expectthat our potential expansion into areas and activities requiring additionalexpertise, such as further clinical trials, governmental approvals, commercialmanufacturing and marketing, will place additional requirements on ourmanagement, operational and financial resources. We expect these demands willrequire an increase in management and scientific personnel and the developmentof additional expertise by existing management personnel. The failure toattract and retain such personnel or to develop such expertise could materiallyadversely affect prospects for our success.

 

46

----

Tableof Contents

 

***We will establishcollaborative relationships, and those relationships may expose us to a numberof risks.***

 

We will rely on anumber of significant collaborative relationships with pharmaceutical or otherhealthcare companies for our manufacturing, research funding, clinicaldevelopment and/or sales and marketing performance. Reliance on collaborativerelationships poses a number of risks, including the following:

 

·wecannot effectively control whether our corporate partners will devotesufficient resources to our programs or product candidates;

·disputesmay arise in the future with respect to the ownership of rights to technologydeveloped with collaborators;

·disagreementswith collaborators could delay or terminate the research and development,regulatory approval or commercialization of product candidates, or result inlitigation or arbitration;

·corporatepartners may have considerable discretion in electing whether to pursue thedevelopment of any additional product candidates and may pursue technologies orproducts either on their own or in collaboration with our competitors; and

·collaboratorswith marketing rights may choose to devote fewer resources to the marketing ofour product candidates than they do to product candidates of their owndevelopment.

 

In July 2004,we entered into a collaboration, license and supply agreement with Nycomed inwhich we granted Nycomed rights to develop and market Imagify in Europe. Therecan be no assurance that the regulatory goals, sales targets and otherobjectives of this agreement will be achieved. Failure to achieve these goals,targets and objectives would result in our inability to receive license,milestone, royalty and other payments under this agreement, which would have amaterial adverse impact on our business, financial condition and results of operationsincluding, under certain conditions, reduction of royalty rates, delays inregulatory approvals and product sales, penalties and termination of theagreement. Under certain provisions of this collaboration agreement, if we failin any material respect to use all commercially reasonable efforts to carry outreferenced obligations under the agreement, we would be obligated to payNycomed liquidated damages of up to $12 million. Although we plan to carryout all of these obligations, which we believe are in our control, there can beno assurance that termination of this agreement will not occur or that suchtermination would not result in us incurring liquidated damages of up to$12 million.

 

Given these risks,our current and future collaborative efforts may not be successful. Failure ofthese efforts could delay our product development or impair commercializationof our products, and could have a material adverse effect on our business,financial condition and results of operations.

 

***Competition in thepharmaceutical industry is intense, and if we fail to compete effectively ourfinancial results will suffer.***

 

We engage in abusiness characterized by extensive research efforts, rapid developments andintense competition. We cannot assure you that our products will competesuccessfully or that research and development by others will not render ourproducts obsolete or uneconomical. Our failure to compete effectively wouldmaterially adversely affect our business, financial condition and results ofoperations. We expect that successful competition will depend, among otherthings, on product efficacy, safety, reliability, availability, timing andscope of regulatory approval and price. Specifically, we expect importantfactors will include the relative speed with which we can develop products,complete the clinical, development and laboratory testing and regulatoryapproval processes and supply commercial quantities of the product to themarket.

 

We expectcompetition to increase as technological advances are made and commercialapplications broaden. In commercializing our initial product candidates and anyadditional products we develop using our HDDS and PDDS technologies, we willface substantial competition from large pharmaceutical, biotechnology and othercompanies, universities and research institutions.

 

·Imagify, our cardiovascular drug and lead product candidate, if approved formarketing and sale, will compete with nuclear stress tests, the currentstandard of care in myocardial perfusion imaging. Nuclear imaging agents thatare approved for use in myocardial perfusion imaging include products marketedby GE Healthcare and Lantheus Medical Imaging. In 2005, the reimbursement rateof a nuclear stress test was approximately $800 per procedure. In addition, GEHealthcare and Lantheus Medical Imaging have developed and marketed ultrasoundcontrast agents that have been used for Left Ventricular Opacification, or LVO,and Endocardial Border Delineation, or EBD, in patients with suboptimal images.No ultrasound contrast agent has been approved by FDA for use in myocardialperfusion imaging using cardiac stress ultrasound. In addition, some companieshave ultrasound contrast agents that are FDA approved for resting cardiacultrasound evaluation of LVO and EBD in patients with suboptimal images or arein development. In the future, these companies may seek to broaden theirindications to include myocardial perfusion assessment with cardiac stressultrasound. These FDA-approved agents include Optison, which is marketed 

 

47

----

Table ofContents

 

by GE Healthcare and Definity, which is marketed by Lantheus MedicalImaging. SonoVue is an ultrasound contrast agent marketed in Europe by Braccofor LVO, EBD and radiology applications.

 

·AI-850 (our reformulation of paclitaxel) or a reformulation of AI-850, ifapproved for marketing and sale, will also face intense competition.  We are aware of companies, such as AbraxisBioscience (formerly American Pharmaceutical Partners), NeoPharm and SonusPharmaceuticals that are applying significant resources and expertise todeveloping reformulations of paclitaxel for intravenous delivery. In early2005, Abraxis Bioscience received FDA approval for and is marketing theirproduct. None of these other reformulations has received approval from FDA.Other companies, such as Cell Therapeutics, are developing new chemicalentities that involve paclitaxel conjugated, or chemically bound, to anotherchemical. None of these new chemical entities have received final approval fromFDA. In addition, a number of companies have developed technology fordelivering hydrophobic drugs. Cardinal Health, CyDex and Elan have createdformulations of hydrophobic drugs that have been approved by FDA.

 

·AI-128,our initial sustained release formulation of an inhaled asthma drug, ifapproved for marketing and sale, will also face intense competition. Companiessuch as Alkermes possess technology that may be suitable for sustained releasepulmonary drug delivery and may have competitive programs that have not beenpublicly announced or may decide to begin such programs in the future. We arenot aware of any other company currently in human clinical development of asustained release version of the asthma drug that is currently the subject ofour research and development efforts. In addition, many asthma drugs aremarketed by large pharmaceutical companies with much greater resources than us.These companies may be developing sustained release versions of their asthmadrugs that would compete with our sustained release product candidate.

 

Relative to us,most of our competitors have substantially greater capital resources, researchand development staffs, facilities and experience in conducting clinical trialsand obtaining regulatory approvals, as well as in manufacturing and marketingpharmaceutical products. Many of our competitors may achieve productcommercialization or patent protection earlier than we will.  Furthermore, we believe that some of ourcompetitors have used, and may continue to use, litigation to gain acompetitive advantage. Finally, our competitors may use different technologiesor approaches to the development of products similar to the products we areseeking to develop.

 

***We expect todevelop international operations that will expose us to additional businessrisks.***

 

We expect, whetherdirectly or through collaborative relationships, to develop operations outsidethe United States in order to market and distribute our products. Regardless ofthe extent to which we seek to develop these operations ourselves or incollaboration with others, we cannot be sure that our international effortswill be successful. Any expansion into international markets will requireadditional resources and management attention and will subject us to newbusiness risks. These risks could lower the prices at which we can sell ourproducts or otherwise have an adverse effect on our operating results. Amongthe risks we believe are most likely to affect any international operationsare:

 

·different regulatory requirements for approval of our product candidates;

·dependence on local distributors;

·longer payment cycles and problems in collecting accounts receivable;

·adverse changes in trade and tax regulations;

·the absence or significant lack of legal protection for intellectual propertyrights;

·political and economic instability; and

·currency risks.

 

**Risks Related to Our Industry**

 

***Even if we obtainmarketing approval, our products will be subject to ongoing regulatory review.***

 

If regulatoryapproval of a product is granted, such approval may be subject to limitationson the indicated uses for which the product may be marketed or containrequirements for costly, post-marketing follow-up studies. As to products forwhich marketing approval is obtained, the manufacturer of the product and themanufacturing facilities will be subject to continual review and periodicinspections by FDA and other regulatory authorities. In addition, the labeling,packaging, adverse event reporting, storage, advertising, promotion and recordkeeping related to the product will remain subject to extensive regulatoryrequirements. The subsequent discovery of previously unknown problems with theproduct, manufacturer or facility may result in restrictions on the product orthe manufacturer, including withdrawal of the product from the market. We maybe slow to adapt, or we may never adapt, to changes in existing requirements oradoption of new requirements or policies.

 

48

----

Table ofContents

 

If we fail tocomply with applicable regulatory requirements, we may be subject to fines,suspension or withdrawal of regulatory approvals, product recalls, seizure ofproducts, operating restrictions and criminal prosecution.

 

***Market acceptance of our products will be limited if usersof our products are unable to obtain adequate reimbursement from third-partypayors.***

 

Government healthadministration authorities, private health insurers and other organizationsgenerally provide reimbursement for products like our product candidates, andour commercial success will depend in part on these third-party payors agreeingto reimburse providers for the costs of our products. Even if we succeed inbringing any of our proposed products to market, we cannot assure you thatthird-party payors, in the United States, Europe and other markets that we maypursue, will consider our products cost-effective or provide reimbursement inwhole or in part for their use or agree to the proposed price.

 

Significantuncertainty exists as to the reimbursement status of newly approved health careproducts. Each of our product candidates is intended to replace or alterexisting therapies or procedures. These third-party payors may conclude thatour products are less safe, effective or cost-effective than these existingtherapies or procedures. Therefore, third-party payors may not approve ourproducts for reimbursement.

 

If third-partypayors do not approve our products for reimbursement or fail to reimburse themadequately, sales will suffer as some physicians or their patients will opt fora competing product that is approved for reimbursement or is adequatelyreimbursed. Even if third-party payors make reimbursement available, thesepayors’ reimbursement policies may adversely affect the ability of us and ourpotential collaborators to sell our products on a profitable basis.

 

Moreover, thetrend toward managed healthcare in the United States, the growth oforganizations such as health maintenance organizations, and legislativeproposals to reform healthcare and government insurance programs couldsignificantly influence the purchase of healthcare services and products,resulting in lower prices and reduced demand for our products which couldadversely affect our business, financial condition and results of operations.

 

In addition,legislation and regulations affecting the pricing of pharmaceuticals may changein ways adverse to us before or after FDA or other regulatory agencies approveany of our proposed products for marketing. While we cannot predict thelikelihood of any of these legislative or regulatory proposals, if anygovernment or regulatory agencies adopt these proposals they could materiallyadversely affect our business, financial condition and results of operations.

 

***We may be required to defend lawsuits or pay damages inconnection with the alleged or actual harm caused by our products or productcandidates.***

 

We face aninherent business risk of exposure to product liability claims in the eventthat the use of our products is alleged to have resulted in harm to others.This risk exists in clinical trials as well as in commercial distribution. Inaddition, the pharmaceutical and biotechnology industries in general have beensubject to significant medical malpractice litigation. We may incur significantliability if product liability or malpractice lawsuits against us aresuccessful. Furthermore, product liability claims, regardless of their merits,could be costly and divert our management’s attention from other businessconcerns, or adversely affect our reputation and the demand for our products.Although we maintain product liability insurance, we cannot be certain thatthis coverage will be adequate or that it will continue to be available to uson acceptable terms.

 

***Rapid technologicalchange could make our products obsolete.***

 

Pharmaceuticaltechnologies have undergone rapid and significant change. We expect thatpharmaceutical technologies will continue to develop rapidly. Our future willdepend in large part on our ability to maintain a competitive position withrespect to these technologies. Any compounds, products or processes that wedevelop may become obsolete before we recover any expenses incurred inconnection with their development. Rapid technological change could make ourproducts obsolete, which could materially adversely affect our business,financial condition and results of operations.

 

***Our products involve the use of hazardous materials, and asa result we are exposed to potential liability claims and to costs associatedwith complying with laws regulating hazardous waste.***

 

49

----

Table ofContents

 

Our research anddevelopment activities involve the use of hazardous materials, includingchemicals and biological materials. We believe that our procedures for handlinghazardous materials comply with federal and state regulations. However, therecan be no assurance that accidental injury or contamination from thesematerials will not occur. In the event of an accident, we could be held liablefor any damages, which could exceed our available financial resources. Thisliability could materially adversely affect our business, financial conditionand results of operations.

 

We are subject tofederal, state and local laws and regulations governing the use, manufacture,storage, handling and disposal of hazardous materials and waste products, andwe spent approximately $42,000 during the nine months ended September 30,2008 to dispose of these hazardous materials and waste products. We may berequired to incur significant costs to comply with environmental laws andregulations in the future that could materially adversely affect our business,financial condition and results of operations.

 

**Risks Related to Our Common Stock**

 

***Our common stock may bedelisted from the Nasdaq Capital Market, which could negatively impact theprice of our common stock and our ability to access the capital markets.***

 

Effective at theopen of business on October 29, 2008, the listing of our common stock wastransferred from the Nasdaq Global Market to the Nasdaq Capital Market. This listing transfer was part of our plan of compliance as presented to theNasdaq Hearings Panel in September 2008 in connection with our appeal ofthe Nasdaq Global Market delisting notice we received on July 14,2008.  We currently fail to meet The Nasdaq Stock Market LLC’s (“NASDAQ”)minimum bid price requirement of $1.00 pursuant to Marketplace Rule 4450(a)(5) andNASDAQ’s $10.0 million minimum stockholders’ equity requirement pursuant toMarketplace Rule 4450(a)(3) for continued listing on the Nasdaq GlobalMarket. We have until December 31, 2008 to show at least $2.5 million instockholders’ equity or demonstrate compliance with one of the alternativelisting criteria for continued listing on the Nasdaq Capital Market, including$35.0 million in market value of listed securities for a minimum of tenconsecutive trading days.  We have until April 17, 2009 to evidence aclosing bid price of $1.00 or more for a minimum of ten consecutive tradingdays.  If we do not satisfy these requirements within these periods oftime, our common stock may be delisted from NASDAQ.

 

In addition to theminimum bid price deficiency described above, as of September 30, 2008, wedo not meet the minimum stockholders’ equity requirement for continued listingon the Nasdaq Capital Market.

 

The delisting ofour common stock from the Nasdaq Capital Market would significantly affect theability of investors to trade our securities and would significantly negativelyaffect the value and liquidity of our common stock. In addition, the delistingof our common stock could materially adversely affect our ability to raisecapital on terms acceptable to us or at all. Delisting from the Nasdaq CapitalMarket could also have other negative results, including the potential loss ofconfidence by suppliers and employees, the loss of institutional investorinterest and fewer business development opportunities.  In the event our common stock is delistedfrom the Nasdaq Capital Market, our common stock may become eligible forquotation and trading on the OTC Bulletin Board.

 

***IfCephalon elects to convert its convertible promissory into shares of our commonstock, it will likely result in immediate and substantial dilution to ourstockholders and potentially give Cephalon control over stockholder votes.***

 

Pursuant to the terms ofthe Cephalon convertible promissory note, Cephalon has the option to convertthe Cephalon convertible promissory note into the number of shares of ourcommon stock equal to 51% of our outstanding common stock on a fully-diluted basison the date of such conversion.  Suchconversion will likely result in immediate and substantial dilution to ourstockholders.  As a majority holder ofour common shares, Cephalon would be able to control certain votes of ourstockholders and may also frustrate or make more difficult the acquisition ofAcusphere by a third party without Cephalon’s approval..  Further, under the terms of our note purchaseagreement with Cephalon, during the restricted period, if we undertake anoffering of certain securities, Cephalon has the right to acquire that numberor amount of such shares of our securities, at the price and upon substantiallythe same terms and conditions as such shares are to be sold or otherwise issuedto third parties, as shall enable Cephalon to maintain, on a fully dilutedbasis and assuming the conversion of all such securities, its ownershipinterest in the Company. Cephalon’s ability to maintain its ownership interestmay also frustrate or make more difficult our ability to issue additional equityand/or debt securities to new investors.

 

***IfCephalon elects to convert its convertible promissory into shares of our commonstock, it will have the right to proportional representation on our board ofdirectors, which would provide Cephalon with an opportunity to exertsignificant control over the strategic direction of Acusphere.***

 

50

----

Table of Contents

 

Pursuant to the terms ofour note purchase agreement with Cephalon, from and after the conversion of theCephalon convertible promissory note and for so long as Cephalon holds at least25% or more of our outstanding voting securities, Cephalon will have the rightto designate that number of directors to our board of directors that isproportional to its equity interest. Cephalon’s ability designate a proportional number of our directorswould provide Cephalon with an opportunity to exert significant control overthe strategic direction of the Company and may also frustrate or make moredifficult the acquisition of Acusphere by a third party without Cephalon’sapproval.

 

***We expect that ourstock price will fluctuate significantly.***

 

The stock market,particularly in recent years, has experienced significant volatilityparticularly with respect to pharmaceutical and biotechnology stocks. An activepublic market for our common stock may not continue to develop or be sustained.The volatility of pharmaceutical and biotechnology stocks and the level oftrading in such stocks do not always relate to the operating performance of thecompanies represented by such stocks. Factors that could cause this volatilityin the market price of our common stock include:

 

·announcements of the introduction of new products by us or our competitors;

·announcements of clinical trial results;

·market conditions in the pharmaceutical and biotechnology sectors;

·rumors relating to us or our competitors;

·litigation or public concern about the safety of our potential products;

·our quarterly operating results;

·deviations in our operating results from the estimates of securities analysts;

· sales by us of additional shares of ourcommon or preferred stock; and

·FDA or international regulatory actions.

 

The market priceof our common stock may also fluctuate in response to the exercise by us ofrights under the terms of our 6.5% convertible exchangeable preferred stock.For example, we may elect to automatically convert the preferred stock if ourcommon stock price has exceeded 150% of the conversion price of the preferredstock for at least 20 trading days during a 30-day trading period ending withinfive trading days prior to the notice of automatic conversion. There is a riskof fluctuation in the price of our common stock between the time when we mayfirst elect to automatically convert the preferred stock and the automaticconversion date. These fluctuations may adversely affect the value of ourcommon stock.

 

***If shares under ouruniversal shelf registration statement are issued, then the price of oursecurities may be negatively affected.***

 

We have onfile with the SEC a universal shelf registration statement on Form S-3(Registration No. 333-134263), which provides for the offer, from time totime, of common stock, preferred stock, debt securities and warrants up to anaggregate remaining availability as of September 30, 2008, ofapproximately $33.5 million, subject to Company’s satisfaction of the criteria for use of Form S-3.The SEC declared the shelf registration statement effective on August 18,2006. SEC rules currentlylimit our ability to utilize a shelf registration statement to no more thanone-third of our unaffiliated public float over any twelve month period.  Subject tothese limitations, market conditions and our capital needs, and to the extentand so long as we are then eligible to use the registration statements underSEC rules, we may again seek to use any remaining availability under the shelfregistration statements by making an offering of securities covered for saleunder the registration statements. In addition, we may amend our shelfregistration statements or file a new shelf registration statement to increaseour potential access to capital. The addition of these securities into themarket may be dilutive to existing stockholders and have an adverse effecton the price of our securities.

 

***Our common stock is junior to our preferred stock withrespect to the right to receive payments in the event of a dissolution,liquidation or winding up of Acusphere.***

 

In February 2005,we issued and sold 900,000 shares of our 6.5% convertible exchangeablepreferred stock. As of November 6, 2008, 310,000 of these shares ofpreferred stock are outstanding. The preferred stock is senior to the commonstock as to liquidation. In the event of our voluntary or involuntarydissolution, liquidation or winding up of Acusphere, holders of our preferredstock will receive a liquidation preference in an amount equal to $50 per share,plus all accrued and unpaid dividends through the distribution date. Only afterholders of the preferred stock have received their liquidation preference andany accrued and unpaid dividends will we distribute assets, if any areremaining, to our common stock holders.

 

51

----

Tableof Contents

 

***Acusphere could bethe subject of securities class action litigation due to future stock pricevolatility.***

 

In the past, whenthe market price of a stock has been volatile, holders of that stock have ofteninstituted securities class action litigation against the company that issuedthe stock. The market price of our common stock has been historically volatileand may remain volatile. Such volatility in our stock price could result inshareholder litigation against us.  Ifany of our stockholders brought a lawsuit against us, we could incursubstantial costs defending the lawsuit. The lawsuit could also divert the timeand attention of our management.

 

***Future sales ofcommon stock by our existing stockholders may cause our stock price to fall.***

 

The market priceof our common stock could decline as a result of sales by our existingstockholders of shares of common stock in the market, or the perception thatthese sales could occur. These sales might also make it more difficult for usto sell equity securities at a time and price that we deem appropriate. As of November 6,2008, we have approximately 49,506,766 shares of common stock outstanding and310,000 shares of convertible preferred stock outstanding that are convertibleinto approximately 2.3 million shares of our common stock, plus up to a maximumof approximately 0.2 million additional shares of our common stock issuable atour option in satisfaction of the maximum dividend make-whole payment on theseshares of preferred stock. All of the shares of common stock issuable uponconversion of our preferred stock will be freely tradable without restrictionunder the federal securities laws unless purchased by our affiliates.

 

***The terms of our outstanding shares of preferred stock mayrestrict our ability to raise additional capital or hamper or prevent anacquisition of us.***

 

In February 2005,we issued and sold 900,000 shares of our 6.5% convertible exchangeablepreferred stock. As of November 6, 2008, 310,000 of these shares ofpreferred stock are outstanding. In the event of our voluntary or involuntarydissolution, liquidation or winding up of Acusphere, holders of our preferredstock will receive a liquidation preference in an amount equal to $50 pershare, plus all accrued and unpaid dividends through the distribution date.Only after holders of the preferred stock have received their liquidation preferenceand any accrued and unpaid dividends will we distribute assets, if any areremaining, to our common stock holders. Without the vote or consent of theholders of at least a majority of the shares of preferred stock, we can notauthorize or sell any equity security that ranks senior to the preferred stockas to dividends or distributions of assets upon liquidation, dissolution orwinding up of Acusphere. As a result of this liquidation preference, it may bedifficult for us to raise additional capital through the sale of common stockor junior preferred stock on acceptable terms, or at all.

 

In addition,without the vote or consent of the holders of at least a majority of the sharesof preferred stock we may not effect a consolidation or merger with anotherentity unless the preferred stock that remains outstanding and its rights,privileges and preferences are unaffected or are converted into or exchangedfor preferred stock of the surviving entity having rights, preferences andlimitations substantially similar, but no less favorable, to the convertiblepreferred stock. This provision could hamper a third party’s acquisition of usor discourage a third party from attempting to acquire control of us via amerger.

 

***Under some circumstances, the holders of our outstandingshares of preferred stock may be entitled to elect some of the directors ofAcusphere.***

 

In February 2005we issued and sold 900,000 shares of our 6.5% convertible exchangeablepreferred stock. As of November 6, 2008, 310,000 of these shares ofpreferred stock are outstanding. Cumulative dividends accrue on our preferredstock at an annual rate of $3.25 per share, payable quarterly on the first dayof March, June, September and December, commencing June 1, 2005. Anydividends must be declared by our board of directors and must come from fundsthat are legally available for dividend payments.  In February 2008 and May 2008, ourBoard of Directors elected not to declare a quarterly cash dividend that wasotherwise payable on March 1, 2008 and June 1, 2008,respectively.  In August  2008, ourBoard of Directors again elected not to declare a quarterly cash dividend inthe amount of $0.8125 per share on the preferred stock that was otherwisepayable on September 1, 2008. This is the third quarterly dividend thathas not been declared and paid on the preferred stock. If we have not paiddividends on the preferred stock in an aggregate amount equal to at least sixquarterly dividends whether or not consecutive, we must increase the size ofour board of directors by two additional directors. After this time, and for solong as these dividends remain due and unpaid, holders of the preferred stock,voting separately as a class with holders of preferred stock ranking on thesame basis as to dividends having like voting rights, will be entitled to electtwo additional directors at any meeting of stockholders at which directors areto be elected. These directors will be appointed to classes on the board asdetermined by our board of directors. These voting rights will terminate 

 

52

----

Table ofContents

 

when we havedeclared and either paid or set aside for payment all accrued and unpaiddividends. The terms of office of all directors so elected will terminateimmediately upon the termination of these voting rights.

 

***Provisions of Delaware law or our charter documents coulddelay or prevent an acquisition of us, even if the acquisition would bebeneficial to our stockholders, and could make it more difficult for you tochange management.***

 

Provisions ofDelaware law or our charter or by-laws could hamper a third party’s acquisitionof us, or discourage a third party from attempting to acquire control of us.Stockholders who wish to participate in these transactions may not have theopportunity to do so. These provisions could also limit the price thatinvestors might be willing to pay in the future for shares of our common stock.Further, these provisions make it more difficult for stockholders to change thecomposition of our board of directors in any one year.

 

These provisionsinclude:

 

·a provision allowing us to issue preferred stock with rights senior to those ofthe common stock without any further vote or action by the holders of thecommon stock;

·the existence of a staggered board of directors in which there are threeclasses of directors serving staggered three-year terms, thus expanding thetime required to change the composition of a majority of directors andpotentially discouraging someone from making an acquisition proposal for us;

·the by-laws’ requirement that stockholders provide advance notice whennominating our directors;

·the inability of stockholders to convene a stockholders’ meeting without thechairperson of the board, the chief executive officer, the president or amajority of the board of directors first calling the meeting; and

·the application of Delaware law prohibiting us from entering into a businesscombination with the beneficial owner of 15% or more of our outstanding votingstock for a period of three years after the 15% or greater owner first reachedthat level of stock ownership, unless we meet specified criteria.

 

***Inconnection with our November 2008 transaction with Cephalon we waived Section 203of the Delaware General Corporation Law and agree to seek shareholder approvalof certain provisions of our certificate of incorporation, which may make itmore difficult to discourage an acquisition of Acusphere by Cephalon or others.***

 

As a condition to theconsummation of our November 2008 transaction with Cephalon we waived Section 203of the Delaware General Corporation Law, the application of which haveotherwise prohibited us from entering into a business combination Cephalonwithout a two-thirds stockholder vote. Further, for so long as the Cephalon convertible note remainsoutstanding or Cephalon holds at least 25% or more of our outstanding votingsecurities, which period we refer to as the restricted period, Cephalon mayrequest that we take all actions necessary to enact an amendment to ourcertificate of incorporation, including calling and holding a meeting of ourstockholders to seek approval of such amendment and filing with the SEC a proxystatement seeking approval of such amendment, which (i) will providethat we expressly elect not to be governed by Section 203 of the DelawareGeneral Corporation Law and/or (ii) will provide that each member of ourboard of directors shall be elected annually for a one year term (i.e. a “staggeredboard”).  In the absence of theseprocedural protections, it would be more difficult for our board of directorsto discourage an acquisition by Cephalon or others.  Notwithstanding the foregoing, any futuretransaction between us and Cephalon must be approved by a committee ofdirectors of our board consisting entirely of directors that are independent ofCephalon.

 

***We have never paid dividends on our common stock, and we donot anticipate paying any cash dividends on our common stock in the foreseeablefuture.***

 

We have paid nocash dividends on our common stock to date and, other than cash dividends paidon our preferred stock, we currently intend to retain our future earnings, ifany, to fund the development and growth of our businesses. In addition, theterms of any future debt or credit facility may preclude us from paying thesedividends. As a result, capital appreciation, if any, of our common stock willbe your sole source of gain for the foreseeable future.

 

**ITEM 2. UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

None

 

**ITEM 3. DEFAULTS UPON SENIORSECURITIES**

 

None

 

**ITEM 4. SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

**None.**

 

53

----

Tableof Contents

 

**ITEM 5. OTHER INFORMATION**

 

Our policygoverning transactions in our securities by its directors, officers andemployees permits our officers, directors and certain other persons to enterinto trading plans complying with Rule 10b5-1 under the SecuritiesExchange Act of 1934, as amended. We have been advised that, in accordance withRule 10b5-1 and our policy governing transactions in our securities, sucha plan has been entered into with provisions requiring that any trading ofsecurities thereunder is to be reported when and if it occurs inaccordance with applicable law. We undertake no obligation to update or revisethe information provided herein, including for revision or termination of anestablished trading plan.

 

**ITEM 6. EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                                                                                                          |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 10.1                |       | Senior  Management Compensation Plan dated July 25, 2008 (Incorporated by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K, filed with the Securities and Exchange Commission on  July 28, 2008)                                                                                                                   |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 10.2                |       | Amendment to  Patent License Agreement by and between the Company and Bracco International  BV, dated as of July 29, 2008 (Incorporated by reference to  Exhibit 10.1 to the registrant’s Current Report on Form 8-K, filed  with the Securities and Exchange Commission on July 28, 2008)                                                   |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 10.3                |       | Letter  Agreement, dated as of September 2, 2008, between Acusphere and  Cephalon, Inc. (Incorporated by reference to Exhibit 10.1 to the  registrant’s Current Report on Form 8-K, filed with the Securities and  Exchange Commission on September 8, 2008)                                                                            |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 10.4                |       | Fourth Amendment  to the Collaboration, License and Supply Agreement dated July 6, 2004,  dated as of September 3, 2008 between Acusphere and Nycomed Danmark ApS  (Incorporated by reference to Exhibit 10.2 to the registrant’s Current  Report on Form 8-K, filed with the Securities and Exchange Commission on  September 8, 2008) |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 31.1*               |       | Rule 13a-14(a) /  15d-14(a) Certification                                                                                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 31.2*               |       | Rule 13a-14(a) /  15d-14(a) Certification                                                                                                                                                                                                                                                                                                              |
|                |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 32.1*               |       | Section 1350  Certifications                                                                                                                                                                                                                                                                                                                                     |

 

----

** filed herewith*

 

54

----

Table of Contents

** **

**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized on this 10th day of November 2008.

 
|     | ACUSPHERE, INC. |
|----------|-----------------|
|     |            |   |
|     | By:             | /s/ Sherri C.  Oberg |
|     |            | Sherri C. Oberg |
| * * | * *        | *President  and Chief Executive Officer* |
|     |            |   |
|     | By:             | /s/ Lawrence A.  Gyenes |
|     |            | Lawrence A.  Gyenes |
| * * | * *        | *Senior  Vice President and Chief Financial Officer* |
| * * | * *        | *(Principal  Financial* *and Accounting Officer and* |
| * * | * *        | *Duly  Authorized Officer)* |

 

55

----

Table ofContents

 

**EXHIBITINDEX**

 
| **Exhibit********Number** | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                                                                                                          |
|---------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                      |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 10.1                      |       | Senior  Management Compensation Plan dated July 25, 2008 (Incorporated by  reference to Exhibit 10.1 to the registrant’s Current Report on  Form 8-K, filed with the Securities and Exchange Commission on  July 28, 2008)                                                                                                                   |
|                      |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 10.2                      |       | Amendment to  Patent License Agreement by and between the Company and Bracco International  BV, dated as of July 29, 2008 (Incorporated by reference to  Exhibit 10.1 to the registrant’s Current Report on Form 8-K, filed  with the Securities and Exchange Commission on July 28, 2008)                                                   |
|                      |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 10.3                      |       | Letter  Agreement, dated as of September 2, 2008, between Acusphere and  Cephalon, Inc. (Incorporated by reference to Exhibit 10.1 to the  registrant’s Current Report on Form 8-K, filed with the Securities and  Exchange Commission on September 8, 2008)                                                                            |
|                      |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 10.4                      |       | Fourth Amendment  to the Collaboration, License and Supply Agreement dated July 6, 2004,  dated as of September 3, 2008 between Acusphere and Nycomed Danmark ApS  (Incorporated by reference to Exhibit 10.2 to the registrant’s Current  Report on Form 8-K, filed with the Securities and Exchange Commission on  September 8, 2008) |
|                      |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 31.1*                     |       | Rule 13a-14(a) /  15d-14(a) Certification                                                                                                                                                                                                                                                                                                              |
|                      |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 31.2*                     |       | Rule 13a-14(a) /  15d-14(a) Certification                                                                                                                                                                                                                                                                                                              |
|                      |       |                                                                                                                                                                                                                                                                                                                                                                  |
| 32.1*                     |       | Section 1350  Certifications                                                                                                                                                                                                                                                                                                                                     |

 

----

** filed herewith*

 

56

----